Extracted from Law360
Predictions of the adverse economywide impact of the COVID-19 pandemic on mergers and acquisitions have been nothing short of apocalyptic. However, the impact of the crisis on health industry consolidations has been mixed.
In particular, for hospitals, and in select other sectors such as physician practice groups, telehealth, behavioral health and specialty practices like eye care and dental services, mergers are either continuing at previous levels or actually picking up momentum in the current environment.
In April, a group of seasoned M&A investors and lawyers co-authored an assessment of the impact of the pandemic on deal-making generally. They maintained that "Global mergers and acquisitions have already plummeted as result of the coronavirus crisis, and by the end of March 2020 had reached a near standstill."
The authors pointed to stalled or terminated deals involving companies in a range of industries, including Xerox Holdings Corp., HP Inc. and Bed Bath & Beyond Inc. They also noted that "private equity sponsors have spent an increasing amount of time on efforts to strengthen or save their existing portfolio companies, at the expense of new deal activity."
Other observers have pointed to other factors that would likely depress M&A activity in the near term, including a dramatic increase in the number of bankruptcies, led by household names like Hertz Global Holdings Inc. and J. Crew Group Inc.
A recent New York Times article indicated that many more companies are teetering on the edge, pointing out that "Edward I. Altman, the creator of the Z score, a widely used method of predicting business failures, estimated that this year will easily set a record for so-called megabankruptcies – filings by companies with $1 billion or more in debt" and "the number of merely large bankruptcies" will "challenge the record set the year after the 2008 economic crisis."
On the other hand, it has become clear that some industries have actually prospered during the pandemic, such as grocery stores, pharmacies, home entertainment companies like Netflix Inc. and Nintendo Co. Ltd., remote working tools like Zoom and Slack, and giant online sellers like Amazon.com Inc. and Wal-Mart Stores Inc. and the delivery infrastructure that serves them.
Many of these companies are likely to be actively searching for acquisitions, like the CVS Health Corp. acquisition of Aetna Inc. last year, meanwhile sitting with piles of cash just waiting — even itching — to be invested in temporarily distressed bargains.
The health care industry is somewhere in the middle, coping with the severe adverse consequences of the pandemic (and for many participants, staring bankruptcy in the face) but also home to organizations and entities that are ripe for mergers and consolidations. The pandemic has clearly generated losers in health care, but there are also some winners.
Losers and winners alike are eyeing mergers and consolidations as survival strategies. Unlike in other sectors, consolidation activity does not appear to have meaningfully slowed in a number of health industry sectors, and the impact of the pandemic may actually lead to an increase in M&A over the next several years.
The hospital industry is not a monolithic industry sector. There are for-profit, nonprofit and governmental segments to the hospital industry, and many different kinds of hospitals, from large, urban teaching hospitals to medium-size suburban facilities to small rural critical-access hospitals. Each segment has been affected by the pandemic in different ways.
Hospital merger activity has not increased dramatically during the COVID-19 crisis, but neither has it subsided to any great extent. In fact, hospital mergers and acquisitions for the first several months of 2020 remained at approximately the same level — 10 deals per month — as in 2017, which was a higher level than in 2018 and 2019.
A significant proportion of this activity has occurred in the investor-owned sector. Examples in the first few months of 2020 include multiple hospital sales by Community Health Systems and Quorum, and multiple acquisitions by HCA Healthcare. Also included in this trend (and apparently undaunted by the current crisis) is the leveraged buyout announced in early June of the 37 hospitals of Steward Health by a group of its physicians led by the company's founder and CEO.
At the same time, there has also been considerable ongoing consolidation in the nonprofit and governmental segments of the industry, the sectors with which I am the most familiar.
High-volume urban hospitals have tended to be the providers of a substantial majority of COVID-19 services nationally and continue to do so as the virus increases in new hotspots around the country. These hospitals, while severely impacted in negative ways, at least have remained full for much of the last three months, albeit with victims of the pandemic displacing more lucrative elective surgeries.
It could be argued that the real losers were the hospitals that did not see a lot of COVID-19 patients but were required to cease elective procedures anyway to ensure that capacity was available if needed. Federal funding continues to be doled out in tranches to these hospitals, and it remains to be seen whether they can ever be made whole.
Many of these hospitals, which tend to be either nonprofit or governmental, have also achieved previously unseen levels of local cooperation with one another, leading to increased consideration of the possibility of more permanent consolidation.
Mergers and acquisitions among nonprofit and government hospitals are different from consolidations and divestures in the investor-owned sector. While cash purchases are not unknown in these sectors, nonprofit and governmental consolidations more often involve commitments of future investment by the acquiring system or in the case of governmental hospitals, an agreement to shield governmental entities from the uncertain need for future subsidies.
These mergers are often accomplished with member substitutions rather than outright acquisitions, or occasionally through the use of interim steps like management services agreements. For example, Baptist Health Systems' acquisition of Hardin Memorial Health, which is scheduled to close on Sept. 1, involves a combination of $361.4 million in payments and investments.
The COVID-19 pandemic has uncovered dramatic and widening differences between the haves and have-nots in the nonprofit and government hospital sectors. Large nonprofit systems have continued to consolidate, to grow stronger and wealthier.
While the Mayo Clinic reported that the pandemic could lead to upwards of $1 billion in losses for the system, those losses can be read against the backdrop of nearly $13 billion in revenues, and the losses will be made up in part by federal payments under the various provider relief measures enacted thus far by Congress.
Dignity Health, a West Coast nonprofit Catholic system, received the highest payout of any hospital system in the first allocation of relief funds, $1.2 billion. And Dignity is only half of what is rapidly becoming a major national system called CommonSpirit Health, created by Dignity's 2019 merger with Catholic Health Initiatives.
The expansion plans of such fiscally strong regional and national systems reflect multiyear planning that involves carefully targeted geographic or service-line gaps. These systems are simply not daunted in their strategic planning by the current pandemic. If anything, they see opportunities to continue to grow.
These opportunities are underscored by the financial impact of the crisis on nonprofit and governmental entities generally, which has led to a growing divide between haves and have-nots. A recent study conducted by the University of Nebraska indicates that over 30% of municipalities, 43% of counties and 43% of nonprofit organizations find themselves in difficult financial condition during the pandemic. At the same time, over a quarter of nonprofits indicate that they are in good financial condition.
At the have-not end of the spectrum are stand-alone nonprofit or government hospitals, or smaller local systems, that have experienced serious hardship and will not necessarily be made whole by federal relief payments.
The status of many stand-alone hospitals has been revealed as increasingly perilous by the pandemic, and such hospitals have begun to more actively look for the safety and efficiency of being part of a larger system. These hospitals and small systems are likely candidates for being acquired by the larger, wealthier systems, and they will benefit from such acquisitions in numerous ways.
The pandemic has also generated new interest in consolidation between smaller local or regional nonprofit systems, which have come together to work cooperatively in response to the pandemic. This level of cooperation will likely lead to potential local mergers of equals rather than acquisitions of these hospitals by much larger systems. In sum, for many nonprofit and government hospitals, the world has changed forever, and consolidation may appear to be the only way to ensure their future survival.
Another health industry sector likely to see a significant uptick in M&A activity is in physician services. According to a recent article in the Los Angeles Times, "The coronavirus pandemic, which has fueled widespread speculation about potential long-term changes to American life, is already causing one important shift: It has accelerated moves to restructure how basic medical care is provided and paid for in the U.S."
Primary care physicians in particular started to see a dramatic reduction in patient visits almost from the beginning of the pandemic, causing physicians to begin searching for new ways to be paid in order to survive. As a recent Commonwealth Fund report indicated, "The coronavirus crisis has highlighted the importance of hospitals. But what has also become clear is the increasing importance of a robust, comprehensive primary care system that can help patients avoid hospitals in the first place."
Specialty physician groups also saw a significant reduction in patient visits, due to the elimination or postponement of nonemergency elective surgery. Even hospital emergency departments, which are often staffed by independent contractors, saw far fewer non-COVID-19-related patients due to heightened concern in the population about exposure to the virus.
In wealthier neighborhoods, primary care physicians with stable practices have been able to generate additional revenues by charging monthly or annual concierge type fees — a practice that has been around for a number of years but now appears to be poised for exponential expansion.
But most independent physician groups do not have the luxury of charging such fees, and we are already seeing a substantial increase in such groups seeking safe havens by being acquired by large physician organizations, by hospitals or even by health plans. Quite simply, the pandemic has been a wake-up call for physicians who have come to realize that they cannot risk or afford to be alone anymore.
Several other segments of the health industry appear to be ripe for investments and M&A activity.
As another strategy, physicians and hospitals alike have moved en masse into telehealth. While some observers believe this may be a temporary phenomenon, the shift has been widely hailed by public health experts. Others feel strongly that telehealth as a means of health delivery will become part of the new normal even after the current crisis has faded.
New videoconferencing technology and the increased ease with which physicians are able to review all aspects of a patient's record remotely has contributed to the growth of the practice. While fees remain low, the efficiencies to the health system are obvious. At the same time, there are many different telehealth platforms as part of this new movement, and there is likely to be considerable shakeout in this industry, which is all the more reason for consolidation to occur in the next several years.
This is another medical specialty that is likely to experience a significant increase in M&A activity. The demand for behavioral health services was already expanding before the pandemic, due in part to the national substance abuse crisis.
Observers now feel the behavioral health issues caused or exacerbated by the COVID-19 crisis will generate significant future demand, and while behavioral health is, like telehealth, an area that currently lags behind in terms of reimbursement, that has not deterred investors and larger behavioral health corporations and hospital systems from focusing on acquisitions in this sector.
Finally, there are a number of specialty practice areas that have been adversely impacted by the COVID-19 crisis, largely through being considered nonessential and thus closed for many weeks. These closures have generated financial pressures that will cause many of these practices to search for the safety of investors and larger companies. In particular, we are already seeing an uptick in merger and consolidation activity in areas like eye care and dental health — a trend that we expect to continue.
Challenges and the Future
In conclusion, while there are a number of health industry sectors where we see a continuation or growth of consolidation activity, there are also several challenges that will need to be addressed in current and future deals. Remote deal-making and diligence will likely slow down the process of finalizing deals, as will concerns about how to value a hospital, physician practice or other potential acquisition in the midst of a pandemic. The time it may take to receive regulatory approvals may also lengthen the deal-making process, with regulators as well as dealmakers working remotely.
That said, it is clear that many health industry participants — including nonprofit and governmental entities — will continue to see the need for the future protection of the financial and operational strength of larger systems, and that, in turn, should continue to fuel M&A in at least some segments of the industry.
 Harroch, Richard D., David A. Lipkin and Richard V. Smith, "The Impact of the Coronavirus Crisis on Mergers and Acquisitions," Forbes, April 20, 2020, accessed on February 18 at https://www.forbes.com/sites/allbusiness/2020/04/17/impact-of-coronavirus-crisis-on-mergers-and-acquisitions/#78a7f0a3200a.
 Walsh, Mary Williams, "A Tidal Wave of Bankruptcies Is Coming," New York Times, June 22, 2020, at B1.
 Valinsky, Jordan, "Business Is Booming for These 14 Companies During the Coronavirus Pandemic," CNN Business, May 7, 2020, accessed on June 19 at https://www.mercurynews.com/2020/05/07/business-is-booming-for-these-14-companies-during-the-coronavirus-pandemic/.
 Paavola, Alia, "Hospital M&A Activity Dipped 27% in 2019," Becker's Hospital Review, January 21, 2020, accessed at https://www.beckershospitalreview.com/hospital-transactions-and-valuation/hospital-m-a-activity-dipped-27-in-2019.html.
 Maddox, Will, "Physicians Buy Out Steward Health Care from Private Equity Group," Healthcare Business, June 5, 2020, accessed on June 22 at https://www.dmagazine.com/healthcare-business/2020/06/physicians-buy-out-steward-health-care-from-private-equity-group/.
 "Hardin Memorial Health Will Join Baptist Health in September," The Lane Report, May 8, 2020, accessed on June 19 at https://www.lanereport.com/125486/2020/05/hardin-memorial-health-will-join-baptist-health-in-september/.
 Maher, Craig S, Trang Hoang and Anne Hindery, "Fiscal Responses to COVID-19: Evidence from Local Governments and Nonprofits," Public Administration Review, May 20, 2020, at https://onlinelibrary.wiley.com/doi/full/10.1111/puar.13238?af=R, accessed June 22, 2020.
 Levey, Noam N., "Coronavirus Already Changing Medical Care in the U.S.," Los Angeles Times, April 10, 2020, accessed June 15 at https://www.latimes.com/politics/story/2020-04-10/coronavirus-lasting-changes-healthcare.
 Levey, Supra Note 8. See also Lewis, Corrine, Shanoor Seervai, Tanya Shah, Melinda K. Abrams, and Laurie Zephryn, MD, "Primary Care and the COVID-19 Pandemic," To The Point, Online Publication of The Commonwealth Fund, April 22, 2020, accessed June 22 at https://www.commonwealthfund.org/blog/2020/primary-care-and-covid-19-pandemic.
 Brodwin, Erin, "Telehealth Can Help Fight the Novel Coronavirus, but U.S. Challenges Could Limit Its Potential," STATnews.com, February 28, 2020, accessed on June 18 at https://www.statnews.com/2020/02/28/coronavirus-telehealth-digital-health-us-hospitals-companies-face-challenges/.