Medical Mergers Are in Remission

Like the lull after a busy night in the ER, merger mania among local hospitals is taking a breather. Fast-growing chains are pulling back a bit to strengthen their balance sheets and even unload some facilities they recently acquired. Some hospitals in the San Fernando Valley area are still independent and say they’ll be staying that way, at least for now.

No one seems to be betting, though, that things will stay quiet for very long. Hospitals are already under financial strain, with many operating in the red. They still have to bargain with powerful managed-care health plans, and they face the coming one-two punch of Medicare reimbursement cuts and state seismic upgrade requirements.

So hospitals are still looking for strength in numbers.

“The one thing about health care is that everybody talks,” said Bernard Glossy, chief executive officer of Verdugo Hills Hospital in Glendale. “I don’t think there is any hospital executive around who isn’t talking with somebody” about a merger, a joint venture or some other linkage.

As for his own hospital, an independent, Glossy said, “We’re talking to everyone about everything”--though he added that nothing “concrete” is in the works.

The pace of hospital mergers in Southern California declined last year, after a sharp rise that peaked in 1997.

According to the Healthcare Assn. of Southern California, 1997 saw 35 consolidation deals (either acquisitions, joint ventures, mergers or affiliations), compared to just 16 two years earlier.

In 1998, according to the HASC, 18 hospitals in the region were involved in some sort of consolidation--mostly mergers and acquisitions. Eight of those were part of one deal, the year’s biggest, in which San Francisco-based Catholic Healthcare West merged with UniHealth hospital system last December. Two Valley area hospitals changed hands at that time--Glendale Memorial and Northridge Hospital Medical Center (which has two campuses, in Northridge and Van Nuys).

Since then, the hospital market has been quieter. In a sort of merger morning-after, big hospital buyers like CHW and the for-profit Tenet Healthcare Corp. now seem more focused on integrating their recently acquired properties into logical systems and unloading the ones that don’t make strategic sense.

Financial pressures also are playing a part. CHW saw its bond rating lowered in June by Moody’s Investors Service and it says it will report an operating loss of more than $220 million for the fiscal year ending June 30. It’s currently in talks to spin off two Orange County hospitals--La Palma Intercommunity and Martin Luther Hospital Anaheim--that it picked up as part of UniHealth.

Tenet, which owns Encino-Tarzana Medical Center, has announced plans to sell up to 20 hospitals nationwide, though a company spokesman said no California hospitals would be on the block. On the other side of the merger table, independents looking for merger partners sometimes have trouble finding a suitable match. Talks between CHW and Henry Mayo Newhall Memorial Hospital ended in May; a spokeswoman for the hospital said CHW made the decision to break them off.

Executives and health-care industry analysts say hospitals are finding mergers no magic bullet.

“There is nothing about merging two inefficient hospitals that will make them efficient,” said Paul Torrens, a professor of health services at UCLA’s School of Public Health.

Mergers can bring some economies of scale in purchasing, Torrens said, and can sometimes create enough bargaining power to make the health plans “back off a bit” in negotiating rates and contracts with hospitals.

But he said they don’t make up for internal problems, such as poor quality control or outdated computer systems.

“If mergers are done for the right reasons, they help,” Torrens said. “If you’re acquiring things just to keep busy and get bigger, they don’t always work.”

Still, the economic forces that make hospitals want to band together aren’t going away. If anything, observers say, they’re strengthening. One is the prospect of new cuts in Medicare payments. These are already in the law, as part of the 1997 Balanced Budget Act, and hospitals are lobbying hard to get some relief. If the law doesn’t change, HASC Executive Vice President Jim Lott said, hospitals face an eventual 20% cut in Medicare reimbursement that will sap $7 billion from their revenue over the next five years in California alone.

A June report from the Baltimore-based health-care information firm HCIA says the cuts could drive hospital profit margins, now averaging 5% nationwide, to less than zero by 2002.

Hospitals on the east and west coasts would be more at risk, HCIA said. Steven Valentine, a Los Angeles-based consultant who advises hospitals on mergers, said the balanced-budget act has “really hurt hospitals, and it gets more painful as the years go on.”

California hospitals also face a state mandate to bring their buildings up to strict state seismic safety standards. That will strain capital budgets and, analysts say, lead hospitals in distress to seek merger partners with strong balance sheets and borrowing power.

San Fernando Valley-area hospitals are getting help in this task from the Federal Emergency Management Agency, but FEMA funds don’t cover all the bills. Valley Presbyterian Hospital in Van Nuys, for instance, is getting about $50 million in FEMA funds, but Hal Wurtzel, the hospital’s vice president for corporate development, said this still leaves it “several million dollars” short of what it needs to carry out its upgrade plan.

“We’re looking at a major development campaign” to raise the money, Wurtzel said.

That’s not the only financial challenge. The bargaining clout of health plans, especially in a managed-care stronghold such as Southern California, keeps hospitals looking for mergers or alliances that can give them enough market dominance to win a good price for their services.

“When the buyers are merging, the sellers have to merge to win back the market,” said HASC’s Lott. “That’s Economics 101.”

Lott said last year’s dip in consolidations was only a temporary departure from the long-term trend. Eventually, he said, California’s hospital market will be dominated by a dozen large systems. He said about 20 systems now control 80% of the hospitals.

Ed Vanacore, an analyst with the investment firm of Sutro & Co., said for-profit chains are gearing up for future acquisitions by cleaning up their balance sheets and selling properties outside their target markets.

In time, Vanacore said, they may be able to put their restored buying power to work picking up distressed hospitals.

“A lot of hospitals in this industry,” Vanacore said, “will be encountering some trouble, and this may create some consolidating opportunities.”

In the San Fernando Valley region, a hint of hard times to come can be seen in the recent financial results of local general acute care hospitals. Of the 20 private-sector hospitals in the Valley, Burbank, Glendale, Santa Clarita and the Antelope Valley [see chart], only seven had break-even or better operating results during 1998, according to figures from the Office of Statewide Health Planning and Development.

Eleven had operating losses (individual financial reports were not available for the two Kaiser Foundation hospitals). Of the seven independents, five showed losses and two operated in the black.

The figures did show that a stand-alone hospital can make money. One of them, Valley Presbyterian Hospital in Van Nuys, has had positive results for nine years running and says it sees no reason to look for an angel of mercy. For some of the other independents, the future may not inspire such a sense of self-reliance.

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By the Numbers

Financials for general acute care hospitals in the San Fernando Valley, Santa Clarita Valley, Glendale and Burbank for the year ending Dec. 31, 1998. Dollar amounts are in millions.