Post-Acute Sector M&A: Currently Under a Yellow Flag

Nothing kills the momentum and excitement of race day more than the yellow flag and deployed safety car. Unsafe track conditions, usually caused by an accident, debris on the track or a stopped
vehicle, can cause the marshals to slow down the race. Momentum moderates and
adrenaline wanes. Drivers are forbidden from overtaking, and victory is temporarily out of
sight for all but the lead car. As I watched the Indy 500, 24 Hours at Le Mans and a
handful of Formula One grand prix over the last several weeks, it struck me that postacute sector M&A (home health, hospice, Medicaid PCS, pediatric PDN/therapy) is currently racing under yellow flag conditions. Temporary, but nonetheless frustrating for all constituents involved.


The post-acute sector’s two record setting years in terms of transaction activity, valuation
multiples and quality of companies acquired, 2020 and 2021, now appear to be in the
rearview mirror. In their stead is a sluggish 2022, with companies staying in their lanes,
focused inwardly on operations and trying to regain levels of growth and profitability of
prior years. It should come as no surprise that sector activity has slowed: (i) the supply of
actionable platforms is materially lower than in the prior two years; (ii) the COVID spawned labor market continues to create one of the most challenging operating
environments in recent memory; (iii) home health reimbursement faces a potentially
challenging outlook when the CY 2023 HH PPS rule is finalized in the Fall; and (iv) buyers
are less willing to give credit for COVID-related EBITDA adjustments.


Lower Inventory of Actionable Platforms
Many of the most actionable privately-held and sponsor-owned platforms transacted at a
kinetic pace in 2019, 2020 and 2021. As a result, the number of available platforms is
relatively low, and the sector is currently in a holding pattern, where businesses are (i)
focused on operating in a challenging environment, (ii) too early in their hold period, or (iii)
waiting for financial performance to improve, before coming to market. There is a large
and growing backlog of businesses that we expect to come to market when overall
conditions improve, potentially as early as Q4 2022. But in the meantime, the market is
generally in wait and see mode.


Labor Market’s Impact on Performance
Q4 2021 was one of the most challenging quarters for post-acute operators, particularly
hospice, as the Omicron variant wreaked havoc on staffing and admissions volumes.
Despite strong referral volumes and demand for post-acute services, the inability to

sufficiently hire and retain clinical staff has had a material impact on monthly sequential growth and TTM performance. For many, Q1 2022 was only marginally better, and for some, Q2 2022 continues to present challenges, although, anecdotally, the clinical labor market appears to be improving and may even accelerate due to the looming recession. As a result, companies are deciding, or being forced, to delay sale processes as they attempt to replace poor financial performance in Q4 2021 and Q1 2022 with improved 2H 2022 growth and profitability.


Pending CY 2023 Home Health PPS Rule
Based on the proposed rule released last week, CMS estimates that Medicare payments to home health agencies in CY 2023 would decrease in the aggregate by -4.2%, or -$810 million compared to CY 2022. Without getting too technical and comprehensive, this decrease reflects the effects of the proposed 2.9% home health payment update percentage ($560 million increase), an estimated 6.9% decrease that reflects the effects of the proposed prospective, permanent behavioral assumption adjustment of -7.69% ($1.33 billion decrease), and an estimated 0.2% decrease that reflects the effects of a
proposed update to the fixed-dollar loss ratio (FDL) used in determining outlier payments ($40 million decrease). Prospective home health sellers will most likely wait for better clarity on the final rule before coming to market.


Market Push Back on COVID-Related EBITDA Adjustments
Buyers and lenders have materially increased their scrutiny of COVID-related volume adjustments to EBITDA. Early in the pandemic, the market was quite willing to pay sellers for normalized volumes and financial performance, as if “COVID had not happened.” 27 months later, the market is taking a harder line. “What if” earnings credit is no longer being given wholesale. The market has taken the position that labor staffing challenges and higher labor wage expense are here to stay (for now), and, unless a seller has clearly demonstrated a trend to the contrary, little to no valuation / leverage credit
will be given for such adjustments. As a result, prospective sellers must increasingly rely on actual earnings to ensure the achievement of valuation expectations.

Returning to our racing analogy, post-acute sector M&A is currently under a yellow flag. And while yellow flag conditions produce little to no racing action, and can last for many laps, they are still only temporary. Drivers and their teams can use the time to their advantage – to “box” or “pit” in order to change tires, refuel or tweak the car – so that they are ready to drop the hammer once the yellow flag is lifted. This is exactly what the higher quality post-acute platforms are doing. Some of the most exciting action in a race comes once the safety car exits the track and green flag racing resumes. Given the strong near- and long-term demographic and sector trends supporting the post-acute sector, and the almost unlimited demand for high quality post-acute platforms, there is little doubt that M&A activity will resume with a vengeance.

Two more hospital mergers scrapped after federal antitrust scrutiny

https://mailchi.mp/3390763e65bb/the-weekly-gist-june-24-2022?e=d1e747d2d8

Steward Health Care is abandoning its proposal to sell five Utah hospitals to HCA Healthcare, and New Jersey-based RWJBarnabas Health dropped its plan to purchase New Brunswick, NJ-based Saint Peter’s Healthcare System. These pivots come just weeks after the Federal Trade Commission (FTC) filed suits to block the transactions, saying they would reduce market competition. The FTC said in a statement that these deals “should never have been proposed in the first place,” and “…the FTC will not hesitate to take action in enforcing the antitrust laws to protect healthcare consumers who are faced with unlawful hospital consolidation.” 

The Gist: These latest mergers follow the fate of the proposed Lifespan and Care New England merger in Rhode Island, and the New Jersey-based Hackensack Meridian Health and Englewood Health merger, which were both abandoned after FTC challenges earlier this year.

Antitrust observers find these recent challenges unsurprising, as all were horizontal, intra-market deals of the kind that commonly raise antitrust concerns. What will be more telling is whether antitrust regulators can successfully mount challenges of cross-market mergers, or vertical mergers between hospitals, physicians, and insurers. 

Philanthropist backs antitrust lawsuits against large health systems

https://mailchi.mp/8e26a23da845/the-weekly-gist-june-17th-2022?e=d1e747d2d8

 Consumers and employers recently filed lawsuits against Hartford HealthCare, HCA Healthcare, and Advocate Aurora Health, accusing the health systems of using their market power to increase prices through anticompetitive contracting practices. New reporting from the Wall Street Journal finds that all three suits are receiving funding from billionaire John Arnold, through his charitable foundation Arnold Ventures, which has sponsored several efforts to reduce healthcare spending. While the health systems say that the claims are baseless, the law firm leading the suits, Fairmark Partners, says that it’s attempting to enforce antitrust laws through the courts.

The Gist: Amid the Biden administration’s increased scrutiny of health system anticompetitive behavior, state governments and philanthropic groups are also taking a more active role in challenging hospital deals and contracting practices. 

While these groups have targeted hospital prices because they’re a significant source of increased healthcare spending, these lawsuits do little to address the perverse underlying incentives that push hospitals to seek higher prices from commercial patients, to cross-subsidize what they view as insufficient pricing from public payers.

The Federal Trade Commission (FTC) wants more information on UnitedHealth’s $5.4B LHC deal

https://mailchi.mp/8e26a23da845/the-weekly-gist-june-17th-2022?e=d1e747d2d8

LHC, a postacute care behemoth with several hundred home health and hospice locations, as well as a dozen long-term care hospitals, would greatly expand Optum’s ability to provide home-based and long-term care. The FTC’s second request for information threatens to delay the deal, which was set to close in the latter half of this year. 

The Gist: The LHC deal is the second UnitedHealth Group (UHG) transaction that antitrust regulators have targeted recently. The Department of Justice filed a lawsuit earlier this year to block UHG’s acquisition of Change Healthcare, alleging that acquiring a direct competitor for claims solutions would reduce competition. 

The FTC has historically focused its efforts on horizontal integration, but the LHC scrutiny, in combination with a recent inquiry into pharmacy benefit managers, indicates its focus may be expanding to vertical integration.

The Fed’s big mistake

The Federal Reserve just raised interest rates by three-quarters of a percentage point, the biggest single increase in interest rates since 1994. It’s another move in the Fed’s effort to tackle the fastest inflation in four decades.

I understand the Fed’s urgency, but it has entered dangerous territory. If the Fed continues down this path – as it has signaled it will – the economy will be plunged into a recession. Every time over the last half century the Fed has raised interest rates this much and this quickly, it has caused a recession.

Besides, interest rate increases will not remedy the major causes of the current inflation – huge pent-up worldwide demand from two years of pandemic, shortages of goods and services responding to that demand, Putin’s war in Ukraine, and big profitable corporations with enough pricing power to use inflation as a cover for pushing up prices even further.

The Fed assumes that price increases are being driven by wage increases — so-called “wage-price inflation.” That’s incorrect. Wages are lagging behind inflation. A more accurate description of what we’re now seeing might be called “profit-price inflation” — prices driven upward by corporations seeking increased profits. (See chart below, from the Economic Policy Institute.)

A recession will be especially harmful to people who are most vulnerable to downturns in the economy — who are the first to be fired (and last to be hired again when the economy turns upward): lower-wage workers, disproportionately women and people of color.  

The Fed is making a big mistake.

RWJBarnabas scraps deal to acquire St. Peter’s

RWJBarnabas Health on Tuesday called off its attempt to acquire St. Peter’s Healthcare System in New Brunswick, N.J., days after the Federal Trade Commission sued to block the proposed transaction.

Hospitals scooping up physician practices increases health care prices

https://mailchi.mp/tradeoffs/research-corner-5222129?e=ad91541e82

This week’s contributor is Aditi Sen, the Director of Research and Policy at the Health Care Cost Institute. Her work uses HCCI’s unique data resources to conduct analyses that inform policy to promote a sustainable, accessible and high-value health care system.

High health care prices in the U.S. make it hard for people to access care, difficult for employers to provide insurance, and challenging for policymakers to balance health care spending with other budgetary priorities. That’s why it’s important to understand what drives prices higher and identify policies to keep prices from getting so high.

In a new paper in Health Affairs, Vilsa Curto, Anna Sinaiko and Meredith Rosenthal examined whether hospital and health systems’ acquisition of and contracting with physician practices – two forms of what is often called vertical integration – has led to higher prices for physician services. The researchers combined four sets of data from Massachusetts from 2013-2017 for their analysis.

They found that: 

  • The percent of physicians who joined health systems grew meaningfully: The percent of primary care physicians who remained independent dropped from 42% in 2013 to 31.5% in 2017, and the percent of independent specialists fell from 26% to 17%.
  • Over this same period, prices for physician services rose. Price increases were especially large – 12% for primary care physicians and 6% for specialists – when physicians joined health systems that had a high share of admissions in their area. 

This study stands out for several reasons. First, it shows vertical integration drives up health care prices. Second, the authors highlight actions states can and are considering taking to monitor and curb vertical integration, including antitrust enforcement and enacting laws to promote competition.

Finally, the Massachusetts data allow the public to better appreciate what’s happening across the state. Many earlier studies on health care consolidation have been limited to a subset of insurers, physicians or patients. Massachusetts is a leader when it comes to creating and sharing its data thanks to its all-payer claims database, which pulls together all the health care bills from private insurers and public programs like Medicare and Medicaid in the state. This critical information helps to illuminate patterns of care and prices and connect them to issues like consolidation and competition. Neither the federal government nor most states track how vertical integration mergers influence health care prices.

As these findings demonstrate, acquisitions and other forms of vertical integration impact what people pay for health care services. Given that prices in this sector continue to climb, this paper underscores the need for more state and national data to understand the downstream effects on all of us who use and participate in the U.S. health care system.

The FTC says it’s getting tougher on hospital consolidation. Antitrust experts aren’t buying it

FTC Chairwoman Lina Khan

Two lawsuits against hospital mergers announced the same day may look like the FTC under Chair Lina Khan (pictured) is flexing its muscle to restrain deals that raise prices. But those complaints are “more smoke than fire,” Ken Field, a former FTC lawyer and current co-chair of Jones Day’s global health care practice, told STAT’s Tara Bannow.

The real target shouldn’t be the mergers in Utah and New Jersey between hospitals, antitrust experts said, but something called vertical mergers, in which hospitals buy up physician groups. After such deals, doctors spent $73 million more on 10 common imaging and lab tests over four years, a 2021 Health Affairs study found.

An FTC spokesperson didn’t comment on the agency’s strategy with respect to hospital consolidation. 

The Trend of Health System Mergers Continues

While healthcare is delivered locally, the business of healthcare
is regional, and the regions are only getting bigger.
Hospital
and health system mergers alike have continued to shift from
local to regional, and the recently announced merger between Advocate Aurora
Health and Atrium Health clearly highlights that the regions are only getting
bigger.


Advocate Aurora, with a presence in Illinois and Wisconsin, and Atrium Health,
with a presence in North Carolina, South Carolina, Georgia, and Alabama, will
combine to create a $27 billion health system that will span six states and make it
one of the leading healthcare delivery systems in the country. The combined
organization, which will transition to a new brand, Advocate Health, will operate
67 hospitals and over 1,000 sites of care, employ nearly 150,000 teammates, and
serve 5.5 million patients. Together, Advocate Health will become the 6th largest
system in the country behind Kaiser Permanente, HCA Healthcare, CommonSpirit
Health, Ascension, and Providence.


We have seen a number of large health systems come together recently,
including Intermountain Healthcare + SCL Health to create a $15 billion revenue
system, Spectrum Health + Beaumont ($14 billion), NorthShore University Health
System + Edward-Elmhurst Healthcare
($5 billion), LifePoint Health + Kindred
Healthcare
($14 billion), and Jefferson Health + Einstein Healthcare Network ($8
billion).


The exact reasoning for each merger differs slightly, but one of the common
threads across all is scale.
But not scale in the traditional M&A sense. Rather,
scale in covered lives; scale in physician infrastructure and alignment; scale in
clinical and operational capabilities; scale in technology, innovation, and
partnerships with non-traditional players; scale for capital access; and scale for
insurance risk to compete in a value-based world. It is no longer the strong
acquiring the weak. Rather, strong players are coming together to gain scale to
face the headwinds in a unified manner.

For Advocate Aurora and Atrium, coming together is about leveraging their combined clinical excellence,
advancing data analytics capabilities and digital consumer infrastructure, improving affordability, driving health equity, creating a next-generation workforce, research, and environmental sustainability. Together, they have pledged $2 billion to disrupt the root causes of health inequities across underserved communities and create more than 20,000 new jobs.


Both Advocate Aurora and Atrium are no strangers to mergers. Advocate and Aurora came together in 2018, and prior to that Advocate was intending to merge with NorthShore before being blocked due to anti-trust. Atrium has grown over the years, merging with systems such as Navicent Health in Georgia in 2018, Wake Forest Baptist Health in North Carolina 2020, and Floyd Health System in Georgia in 2021. In the newly proposed merger, Advocate Aurora and Atrium are coming together via a joint operating arrangement where each entity will be responsible for their own liabilities and maintain ownership of their respective assets but operate together under the new parent entity and board. This may allow the combined entity more flexibility in local decision-making. The current CEOs, Jim Skogsbergh and Eugene Woods will serve as co-CEOs for the first 18 months, at which point Skogsbergh will retire, and Woods will take over as the sole CEO.


Mergers can come in various shapes and structures, but the driving forces behind consolidation are not unique. With the need to compete in value-based care, adequately manage risk, gain scale across covered lives, physicians, and points of access, successfully deliver affordable high-quality care, and the need to deal with the vertical and horizontal consolidation of the large-scale payers, the markets that health systems operate in must be large enough to be effective and relevant. We fully expect to see more of these larger scale health system mergers in the near term.


The physical delivery of healthcare is local, but, again, the business of healthcare is not; it is regional, and the regions are only getting bigger.