Financial pressure is pushing more health system transactions

In the third quarter (Q3) of 2023, there were 18 healthcare transactions, up from 10 during the same time in 2022 and seven in 2021. According to a new report from Kaufman Hall, this increase in healthcare transactions suggests that merger and acquisition (M&A) activity is returning to its pre-pandemic levels.

However, many health systems are still facing significant financial difficulties from the pandemic. Hospitals' median operating margins have improved since 2022, but they are still quite low. Currently, median operating margins are just slightly above 1%, which is below the 3% or higher margin needed for long-term financial sustainability.

Out of the 18 healthcare transactions that occurred in Q3, seven, or almost 40%, involved organizations that cited "financial distress" as a driver for the transaction.

"We are seeing continued activity among systems with annual revenues in the range of $250 million to $750 million that have sought a partner," Kaufman Hall wrote. "What is new in recent quarters is the number of larger systems—those with annual revenues of $1 billion or more—that also are citing financial distress as a driver for their decision to partner."

There was only one deal that was considered a "mega-merger," where the smaller party had annual revenues above $1 billion. This mega-merger brought Q3's total transaction revenue to $8.2 billion and average seller size by revenue to $453 million. Although these numbers were below Q2 of this year and Q3 of 2021 and 2022, it is still higher than Q3 of years prior.

"When removing the mega-mergers from each quarter, the average revenue in Q3 was actually significantly higher than that of Q2, at $243 million and $159 million respectively, demonstrating the significant uptick in activity in sizable independent hospitals seeking out partnerships with larger organizations," Kaufman Hall wrote.

Nonprofit health systems represented the larger party in 14 of the 18 deals, and half involved academic or university-affiliated organizations. According to Kaufman Hall, academic/community health system partnerships may help alleviate occupancy pressures at academic hospitals while expanding opportunities for residency programs, clinical research trials, and more.

Among the four remaining deals with for-profit acquirers, three involved a smaller organization in financial distress. Two deals also had "creative transaction structures" that allowed an organization to sell off smaller stakes "to maintain their independence while building strategic alliances that enhance access to care."

According to Advisory Board's Vidal Seegobin, these findings feel predictable. We knew that cash on hand was declining nationally for nonprofits and that struggling health systems were going to pursue bigger partners to bolster their balance sheets.

Advisory Board's 2023 Strategic Planners Survey results showed that for all but the biggest systems, volume recovery is not translating into margin recovery, Advisory Board's Elizabeth Orr explained.

Despite the overall trend toward margin recovery, financial performance is split between those who are experiencing strong recovery and those who have experienced little recovery to date. Advisory Board's Marisa Nives noted that this trend will likely continue to push financially challenged systems into partnerships with high-performing partners.

In most cases, the challenges for both parties lie in determining which complementary capabilities each can bring to the table that will unlock performance gains.

"The devil is always in the details of these transactions, so the real question of whether these were smart moves is still to be determined," Seegobin said. "But given that we're seeing some green shoots on the margin side, and clear potential to connect community hospitals with academic medical centers to redistribute patient acuity to resource intensity, these mergers have a more intuitive rationale."

Regulatory scrutiny of these transactions is increasing

According to Kaufman Hall, as M&A activity among healthcare organizations returns to pre-pandemic levels, regulatory scrutiny of these transactions has also been on the rise.

In July, the Federal Trade Commission and the Department of Justice proposed new merger guidelines that aim to limit certain types of consolidation. Under the guidelines, organizations would not be allowed to merge if doing so prevents a potential competitor from entering the market or reduces incentives for organizations to pay higher wages.

New state-level legislation could also limit or slow potential M&A activity. For example, Minnesota Attorney General Keith Ellison (D) and state policymakers have designed legislation to increase oversight of healthcare mergers.

In Illinois, lawmakers have proposed legislation that would require healthcare facilities to notify the state attorney general's office of any merger, acquisition, or contracting affiliation 30 days before it closes. California and Pennsylvania have also proposed legislation with similar requirements, and other states may soon do the same.

"There are many compelling reasons for hospitals, health systems, and other healthcare organizations to seek new alliances and partnerships in the current operating environment," Kaufman Hall wrote. "The effect of new guidelines on these transactions will remain unknown until they have been tested in the federal and state judicial systems."

There may be some cases where financially distressed hospital acquisitions show a clearer value proposition for regulatory bodies than mega-mergers, but Nives underscored that this hasn't proved universal across regulatory bodies. (Muoio, Fierce Healthcare, 10/13; Adams, MedCity News, 10/15; Olsen, Healthcare Dive, 10/17; Kaufman Hall report, 10/12)

The past few years have been hard for health system strategic planners, and it's not getting any easier. To find out the top challenges and priorities for the coming year, we surveyed 57 leaders at member organizations. Download the market insights to learn  six key findings from our research.