One of the great myths in rural/community hospitals today is that unless you are part of a bigger system you cannot survive. The acquiring entities, always leery of local opposition to the sale or loss of control of their community hospital — one of any town’s most prized assets — like to use terms like strategic affiliation, or alliance versus acquisition, or merger, the latter two typically denoting the transfer of local governance to a centralized board.
The truth is that there are rural/community hospitals, operating in severe market conditions with dismally weak balance sheets and a long list of must-have capital needs, where an asset sale is the right choice. The problem is there also have been a number of ill-advised such “affiliations” because the current CEO felt inadequate to the challenge or, in a few cases, where the CEO had a lucrative change of ownership clause in their employment contract.
In talking with CEOs and board members who made the decision to align with a larger regional health system, I discovered there is one issue that is frequently not at the top of the pro and con list: what happens if the market conditions that were present at the time of the acquisition change and the system no longer feels compelled to honor their promises? The fact is that the system executive with whom you made the deal may not be in the picture in a couple of years and his or her replacement will decide to “go in a different direction.”
That is, surprisingly, not that unusual.
A CEO I know said he that he routinely suffers from corporation reorganization shock. “We were in fairly good shape when the board decided to find a strategic partner to ensure our long-term viability. We were able to achieve some important strategic concessions regarding the development of our medical staff — recruitment of specialists like orthopedic surgeons — but then after the CEO retired and one more strategic review, about which we were not consulted, they told us that they wanted to focus specialty care resources on the regional flagship hospital, 45 miles away.
“What we did not incorporate into the deal was the option to end the relationship if the system failed to deliver on its promise,” he lamented.
Former CHI executives from that struggling system’s Houston market, said some former St. Luke’s board members rue the day they agreed to the CHI takeover. “It has been a total disaster,” a former CFO quoted one member of the board.
On the other hand there have been some very smart deals. One major regional health system recently agreed to align themselves with a larger one in another part of the state. There was no strategic overlap. The deal provided the smaller system with a substantial capital infusion to close the purchase of five area community hospitals. The smaller system retained local governance control and the larger system won the right to market its managed care products in those markets, something they had been unable to do previously. There are additional financial incentives for the smaller system if they achieve their financial targets. So, as of today, this sounds like a big win-win, especially for the regional system which expanded its footprint and maintained local control just in case their larger partner “decides to go in a different direction.”
A word to boards who are flirting with the idea of finding a partner who will answer their concerns: be careful what you pray for and, unless you are financially desperate, be a tough negotiator. If you have a good balance sheet and a savvy CEO, and if you are willing to fight to protect your community’s most important asset, a merger, strategic alignment, or whatever you want to call the transfer of governance local control to a central office, may not be the right answer.
© 2020 John Gregory Self