Size of hospital merger activity remains on upswing

The number of hospital consolidations for the first quarter still lags pre-COVID-19 pandemic first quarters but the revenue side of the equation rose to levels not seen since 2018.

The first quarter saw 15 announced transactions that involve $12.4 billion of revenues, according to advisory firm Kaufman Hall's quarterly look at not-for-profit and for-profit hospital mergers and acquisition activity.

The number jumped from 12 in the first quarter of 2022 and 13 in 2021 but remains far behind the 29 in 2020, 27 in 2019, and 30 in 2018. The revenues involved, on the other hand, stood out, as that figure ballooned from just $3 billion in 2022, $8.8 billion in 2021, $5 billion in 2020, $4.9 billion in 2019, and was just shy of the previous recent peak of $12.7 billion in 2018.

UnityPoint

"The trend of fewer but larger transactions that characterized 2022 was maintained — the average size of the seller or smaller party in Q1 was $827 million, just below last year's historic year-end average of $852 million," the report said. "Kaufman Hall experts believe that a new type of post-pandemic activity is taking shape as health systems adapt to a new environment of razor-thin — and for many organizations, negative — operating margins."

The first quarter's number tracked closely with the 17 transactions announced in the final quarter of 2022. Last year, 53 announced transactions involved more than $45 billion in total revenue, which exceeded a high of $44 billion in 2017 although the number of deals remained below pre-COVID-19 pandemic numbers.

One so-called mega merger where the smaller party has at least $1 billion in revenues surfaced in the first quarter — New Mexico-based Presbyterian Health Services and Iowa-based UnityPoint Health. "This transaction is also another example of a recent trend toward cross-regional partnerships," the report said.

The systems, which signed a letter of intent in early March, posted a notice on EMMA that on March 30 the merger had advanced with the signing of a definitive agreement to form a new healthcare organization although the closing is still subject to regulatory approvals.

Operational and financial headwinds are rising as a factor in consolidation activity and Kaufman Hall said it expects those pressures may prompt a new wave of transaction activity, with a trend toward partnerships that cross state borders and regions.

In 14 of the 15 announced transactions in the quarter, the acquirer was a not-for-profit health system. Of those 14, three were academic/university-affiliated and five were religious-affiliated organizations.

In the Midwest, one major merger recently closed — combining Sparrow Health and University of Michigan Health — that could trigger a Sparrow upgrade and another is in the works between Wisconsin-based Froedtert Health and ThedaCare.

The systems Tuesday signed a letter of intent to join forces.

"By coming together with the state's leader in regional community health, our combined organization will be poised to meaningfully address health equity and disparities, enhance access to a broader array of services and make it easier for patients to navigate the health care system," Froedtert's President and Chief Executive Officer Cathy Jacobson said in the announcement.

Froedtert's Chief Financial Officer Scott Hawig will serve as CFO of the combined systems. Mark Thompson, chief operating officer and chief financial officer of ThedaCare, will serve as chief transformation investment officer.

Pending needed board approvals and state and regulatory reviews, the systems hope to close the transaction by the end of 2023.

Milwaukee-based Froedtert had $3.1 billion in revenues in fiscal 2021. It operates an academic medical center, five community hospitals, 38 ambulatory clinic sites, ambulatory surgical centers, a digital innovation hub and owns a 50% interest in Network Health, Inc., a provider-sponsored health plan covering 110,000 lives.

Fitch Ratings affirmed Froedtert's AA rating on $626 million of debt last year. S&P Global Ratings rates it AA.

Neehah, Wisconsin-based ThedaCare operates an eight-hospital system in northeast and central Wisconsin and is a Mayo Clinic network member with total operating revenues of $1.16 billion.

Fitch affirmed ThedaCare's AA-minus rating in December. It carries $361 million in debt. Moody's Investors Service last year affirmed its A1 rating and revised its outlook to stable from negative.

Froedtert posted the merger announcement on the Municipal Securities Rulemaking Board's EMMA website, but it did not disclose how the systems would treat its debt after merging.

After receiving final regulatory approval, University of Michigan Health on April 1st closed its deal announced in December to acquire Sparrow Health with combined annual revenues of more than $7 billion.

The deal provides an infusion of $800 million for the struggling Sparrow over the next eight years. For the university health system, the acquisition advances its long-term vision to establish a statewide system of care that was hit with two downgrades in December and required a bondholder waiver on covenant defaults.

The affiliation agreement makes UM Health Corp. the sole corporate member of Sparrow and provides Sparrow with capital and operational support, but the revenues and debt of the two systems will remain separate, according to a December notice.

Moody's in December cut the Sparrow Obligated Group rating to A3 from A2 and warned of the potential for further downward action by assigning a negative outlook. The system has about $414 million of outstanding debt. S&P Global Ratings downgraded the rating to A-minus from A in December. In February, it put the rating on CreditWatch with developing implications as a result of the pending merger.

"Should the merger close, we could raise the rating given the envelopment of Sparrow into the much larger UMH, part of University of Michigan, and its strategic initiatives to expand its statewide health care presence, which would include sizable investment into the Sparrow system," S&P said.

Sparrow published an EMMA notice April 4th that its bondholders had waived the anticipated event of default from the failure to meet debt service covenant requirements for fiscal 2022.

Sparrow's wounds stem from strains felt across the not-for-profit hospital sector from materially higher labor costs, inflationary expenses, and higher length of stays that result in unreimbursed costs but they have cut more deeply into Sparrow's balance sheet metrics than peer institutions.

The 126-year-old Sparrow operates five hospital locations. The system includes an employed physician practice and a health plan. UM Health operates five hospitals. The two systems have partnered through an affiliation agreement since 2019 for pediatric services.