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HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Strategic Options in a Consolidating Market Los Angeles, CA | Date August 16,

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Presentation on theme: "HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Strategic Options in a Consolidating Market Los Angeles, CA | Date August 16,"— Presentation transcript:

1 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Strategic Options in a Consolidating Market Los Angeles, CA | Date August 16, 2012 Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved.

2 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Proposed Topics for Discussion Establishing the Context –National and Local Trends –Industry Dynamics Strategic Options Assessment –Phase I: Education on State of the Industry and Industry Trends –Phase II: Market and Organization Assessment –Phase III: Scenarios, Sensitivities and Assessment of Independent Plan –Phase IV: Evaluation of Strategic Options Critical Questions in Partnership Evaluation 1

3 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. National Trends With A Focus on California 2

4 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Source: The Health Care M&A Report, Irving Levin Associates, Inc., and AHA Hospital Statistics *YTD as of 11/30/2011 Number of M&A transactions, Drivers of hospital consolidation in the past decade Financially distressed community hospitals Community hospitals requiring significant capital for investments, but unable to access the capital necessary to fund those projects % of Hospital in Health Systems Current Trends in Hospital Merger and Acquisition Activity: Hospital Consolidation Trends 3

5 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. “California to Face Budget Challenges for Next 10 Years” California faces a $9.2B budgetary gap in 2012 (down from $26.6B shortfall in 2011), the vast majority of which is expected to be closed via continued cost reduction efforts ‒ On October 27 th, 2011, CMS approved California’s request to cut Medi-Cal payment rates by 10% (although this has been tentatively blocked in the US District Court) ‒ In March 2012, the 9th U.S. Circuit Court of Appeals denied California's request to allow proposed Medi-Cal cuts to take effect while a lawsuit involving the cuts is litigated Additional adopted cost control (and/or revenue) solutions potentially include: –Limit utilization of services (e.g. doctor visits, hearing aids, etc.) –Increased copayments (e.g. physician, clinic, ER, hosp., etc.) –Elimination of Adult Day Health Care –Extension of existing Hospital Fees (i.e. 30 month ext. pending) –Medi-Cal waiver renewal (between CA and federal government) Source: California Department of Finance, Governor’s Budget Summary

6 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Hospital Expenses Starting to Outpace Revenue Growth in the State of California Source: 2011 AHA Hospital Statistics (Excludes Separate Nursing Home Units) Net Revenue Expenses Annual Change in CA Hospital Net Revenues and Expenses,

7 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 6 Pressures are Plentiful and Challenge Organizations to Deliver on Historical Mission While the external pressures of the marketplace and the general uncertainty of healthcare reform may seem nebulous to some, there are a number of tangible stimuli having a direct impact on the bottom line: Decreasing Revenues  Lower/flat volume  Challenging payor mix  Medicare hits to reimbursement  Medicaid hits to reimbursement  Increasing charity care  RAC audits Increasing Expenses  Increasing supply costs  Salary and benefit inflation  Affiliation costs  IT investment  Capital costs (interest)  Pension funding Increased revenue pressures coupled with expense inflation is resulting in slimmer and harder to achieve margins and as a result is challenging many organization’s ability to deliver on their community mission

8 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Source: California Healthcare Almanac: California Employer Health Benefits Survey 2009 Annual Premium Increases vs. Inflation, CA Cumulative Premium Increases vs. Inflation, CA Healthcare Premium Increases Steadily Outpacing Inflation Measures 7

9 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Sources: 2011 AHA Hospital Statistics Similar to National Trends, California Utilization Rates Have Softened the Last Five Years Annual CA IP Utilization Rates, Annual CA HOPD Utilization Rates,

10 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Medicaid Medicare National Inpatient Use Rates, Loosely Managed High Admitting Moderately Managed Medium Admitting Well Managed Low Admitting Commercial Total Population Inpatient Use Rates Will Fall Across All Populations (Inpatient) Source: Miliman. 9

11 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. CT Scans Ambulatory Surgery Source: Milliman, Kaiser State Health Facts, AHA Milliman Projections for National Outpatient and Physician Use Rates Loosely Managed High Admitting Moderately Managed Medium Admitting Well Managed Low Admitting Office/Home/Urg. Care/Physical Exams Visits MRI Usage Inpatient and Outpatient Use Rates Will Decline (Outpatient) 10

12 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 11 Narrow Scope of Operations Broad Class I Contracted Providers Smaller, niche providers, some of which may be in rural communities, that will serve as necessary access points; important, but not critical, components. Class II Major Participants Community hospitals and systems that will work within a network managed by a larger Population Health Manager (PHM) to efficiently provide a broad portfolio of services. These organizations will be critical components of PHM networks. Class III Population Health Managers Large, regional health systems that will be able to provide (either directly or through managed relationships) a full continuum of services, across all service lines and levels of acuity. These organizations will have significant alignment with their medical staffs and will be in a position to accept and manage risk. The New Business Model Creates Three Classes of Providers

13 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 12 The Benefits of Scale To assess the benefits of scale, Kaufman Hall analyzed key financial performance measures between 2005 and 2010 based upon Moody’s Investors Service data. The results focus on the following areas: Profitability Leverage Investment Credit rating 1 Academic Medical Center with multiple sites is included in System category. Source: Information supplied by Moody’s Investors Service based upon published ratios. Revenue Classes Based Upon Net Patient Service Revenue $250M - $500M(N = 103) $500M - $1B(N = 99) $1B - $2B(N = 57) $2B - $4B(N = 36) $4B+(N = 20) (N = 315) Distribution by Facility Type

14 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 13 There is a Clear Distinction Between Organizations Less Than $1B and Greater Than $1B 2010 Capital Spending Ratio Source: Information supplied by Moody’s Investors Service based upon published ratios.

15 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 14 The Benefits of Scale: Profitability Improves Operating MarginTotal Margin 2010 Impact of Scale - $4B+: 0.8 percent 2010 Impact of Scale - $4B+: 1.9 percent Source: Information supplied by Moody’s Investors Service based upon published ratios. $250M - $500M $500M - $1B $1B - $2B $2B - $4B $4B+ 1.9% 0.8%

16 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. New Entrants Are Making a Profound and Immediate Market Impact, Proving There is Not Just One Model The transactions below are noteworthy due to: (i) the size/ scale of the targets, (ii) nature/ form of solicitation, (iii) the terms/ conditions of the transaction or (iv) the lack of previous experience with hospitals of the acquirer 15 Leonard Green & Partners

17 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Dramatic Changes to the Competitive Landscape Occurring 16 The blurring of lines between not-for-profit and for-profit healthcare creates new and more pragmatic competitors The blurring of lines between healthcare’s traditional participants – insurers, hospitals, and physicians – resulting in new market entrants Joint Venture to Form New System Joint Venture to Acquire Catholic Hospitals acquires becomes acquires Other notable California activity: forms an affiliation with acquires

18 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Establishing the Context: Industry Dynamics 17

19 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 18  What does it take to move your organization from a “fee-for-service” to a “fee-for-value” payment system?  Should you be a “first mover” in your market area?  What will be the business relationship between your hospital and community physicians?  What steps do you need to take in order to take risk contracting?  How fast will the payment transition occur away from fee-for-service?  What does future utilization look like given a new business model?  How much capital do you need to make these transitions?  Do you need a partner or can you go it alone? A Remarkable Period for the Management and Governance of Hospitals An Endless List of Questions, Problems, and Challenges

20 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. The Word of the Moment in Healthcare Is “Unsustainable”  The size of the federal budget deficit is unsustainable  The annual increase in the Medicare budget is unsustainable  The percentage of healthcare spending to GDP is unsustainable  State Medicaid programs are unsustainable  The continued transfer of costs to employers and consumers is unsustainable 19 In other words, the old business model is broken and will be replaced with new, yet to be defined business models

21 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 20 Unsustainability Trickles All The Way Down To Your Family: Family of Four – Total PPO Cost Versus Median Family Income % of Income 15%18%26%45%42%38% Sources: KaufmanHall - PPO cost , Milliman; median family income , Census Bureau Notes: 2011 family income is an estimate for Federal FY12; total PPO cost = employer contribution, employee payroll deduction, and employee out-of-pocket co-pays/deductibles. Numbers rounded to nearest hundred.

22 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Any executive or organization that wants to change things should be guided by “a point of view about what’s going on in the world, and you invest around that point of view.” Jeff Immelt Chair and CEO General Electric 21 The Intensity and Velocity of Change in the Hospital Industry Mandates That Organizations Develop a Clear and Cohesive Point of View “The world is a complicated place with oceans of new information sloshing around. To run… an organization it helps if you have a rough idea of what is going on.” The Economist Magazine

23 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 1.Provider revenues will be under severe pressure as payment mechanisms migrate toward value based approaches 2.A new set of core competencies will be required for provider success 3.Inpatient and outpatient use rates will decline 4.Providers will learn how to solve a manufacturing problem 5.Providers will consolidate at an accelerated pace – horizontally and vertically 6.The competitive landscape will be reshaped Kaufman Hall’s Point of View 22 and…none of the above is dependent on new federal healthcare legislation

24 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. New Core Competencies Will Be Required of Hospitals and Health Systems for Success in the Future 23

25 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Healthcare Industry Fragmentation 24 Top 5 Players Top 15 Players The hospital/ health provider industry is highly fragmented Depth and breadth of intellectual capital is limited in most organizations Relatively few providers are essential beyond their core markets Sources: Modern Healthcare’s 2011 Hospital Systems Survey 2011 AHA Hospital Statistics iSuppli Corporation 2010 Semiconductor Suppliers Air Transport Association 2010 Economic Report. Statistics are prior to the United-Continental merger. Proforma for that transaction, the top 5 and top 15 would have made up 70.0% and 89.5%, respectively Drug Store News Top 50 Rx Power Players, April Market size is defined as the revenues of the top 50 players

26 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Healthcare Industry Fragmentation The driver of consolidation in other industries was disruption of the prevailing business model –Response to a change in the revenue model –An imperative for IT sophistication –Innovation/ evolution in the production/ service delivery process –Change in the competitive dynamic/ new market entrants –An aggregation “domino” effect 25

27 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Focus on Retail Pharmacy The incorporation of a pharmacy benefit in health insurance plans shifts payment responsibility from the consumer to the insurer Insurers use their leverage and negotiate lower drug prices with retail pharmacies for their enrollment base Broad geographic coverage (scale) and brand recognition become essential attributes for retail pharmacy success in order to negotiate sustainable rates Sophisticated IT becomes imperative for interface with commercial and governmental programs and now consumers Scale becomes imperative to drive operating costs to their lowest-possible level The independent retail pharmacy all but disappears Source: “Pharmaceutical Marketplace Dynamics: Expenditures, Distribution, Coverage, Pricing.” National Association of Chain Drug Stores. May “History of the Digest.” National Community Pharmacists Association “Consolidation of US Retail Pharmacy Industry. TATA Consultancy Services. August IMS Prescription Market Share; 1995,2010. Drug Stores Business and Industry Profile, Illinois/ US Department of Commerce & Southern Illinois University. 55% Independent Drugstore Market Share % 12% 26

28 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. The Hill Burton Act of 1946 supported capital access for individual communities, sparking investment in community hospitals Support for the local hospital became a source of pride for community leaders and prestige was attached to local hospital Board membership Independent physician staffs maintained a strong preference for locally controlled hospitals over which they could extend influence A relatively cooperative payer market resulted in less price and cost pressure than in other industries Access to capital has been available to both large and small, strong and weak providers during past decades Absence of a dominant player(s) in many markets allowed marginal providers to survive Why Has the Hospital Industry Been Highly Fragmented? 27

29 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Further health insurer consolidation Staggering “new era” intellectual and financial capital requirements Transition from an independent to an integrated physician community Need for a rationalized service distribution system Increasing transparency of quality and outcomes Increased visibility of regional and national healthcare brands Migration of payment mechanisms away from activity-based to quality-/ efficiency-based contracts Evidence of a correlation among size, performance, and capital reinvestment What Has Changed? 28

30 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Community hospitals that are unable to compete (financial distress or lack of access to capital) are consolidating with regional and national not- for-profit systems and for-profit entities Strong stand-alone community hospitals are partnering with regional not-for-profit health systems New not-for-profit health systems are forming Regional not-for-profit systems are consolidating with other regional not-for-profit systems National not-for-profit systems are consolidating with regional and other national not-for-profit systems For-profit hospital management companies (public and private) have repositioned their portfolios and are poised for further acquisitions New private equity financing continues to enter the market The Expected Consolidation Trajectory: The Outlook Is for Increased Consolidation Activity in the Hospital Industry Number of Hospital Transactions Number of Hospital Strategic Options Projects Completed by Kaufman Hall

31 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Strategic Options Evaluation 30

32 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Strategic Options Evaluation Project objective: Determine how the hospital/ health system can best serve its community and fulfill its mission moving forward Three primary types of strategic options projects: –Ability to thrive in the long term as an independent organization –Comparison of remaining independent against the spectrum of partnership options (affiliation, joint venture, merger, sale) –Comparison of remaining independent against partnering with various types of organizations (regional system, AMC, community hospital, for-profit or in-market partner vs. out-of-market partner) “State of the Industry” – planning context Assessment of the hospital’s current strategic and financial position Identification and evaluation of strategic alternatives Scenarios, sensitivities and assessment of independent plan 31

33 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Phase I: Education on the State of the Industry and Trends 32

34 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. 1. Market characteristics and strategic position Demographics Payer analysis Market share trends Competitor analysis 3. Financial evaluation Historical financial performance Balance sheet position Capital structure Financial projections Capital capacity Access to capital Phase II: Market and Organizational Assessment 2. Organizational assessment Service line evaluation Quality and patient satisfaction indicators Medical staff assessment Facilities assessment Utilization 33

35 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Memorial’s Region Is Projected to See No Population Growth 2011 Population Concentration by ZIP Code Population Change by ZIP Code Source: Claritas Hospital 1 Regional 2 Regional 1 AMC Hospital 2 Hospital 3 Hospital 4 Hospital 5 H H Memorial Population Change 65+ Population Change Service Area2011AbsoluteCAGR 2011AbsoluteCAGR Home County100,000-2, % 20,0001, % Secondary County 139, % 7, % Secondary County 220, % 4, % Tertiary County 313, % 2, % Total Service Area172,800-2, % 33,0002, % Images intentionally blurred 34

36 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Just Over Half the County Population Is Government Pay and/or Uninsured County Market Lives Summary by Major Payer 45K Est. 5, K 10,000 5,000 Note: Arrow reflects expected change in covered lives associated with reform legislation, population and market dynamics, etc. Source: HealthLeaders Interstudy. Approx. County Service Area Population 14,000 10,000 35

37 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Memorial Is the Market Leader in the County – Driven by Its Strength in Lower Acuity, Medical Service Lines Total Market Discharges 1,400 Note: Excludes Normal Newborns and Inmigration; 2010 Data is annualized based on 9 months. Source: State inpatient database County Market Share Distribution, Service Line, 2010 Annual 930 3, ,000 36

38 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Source: Hospital website Memorial’s facilities span across multiple counties and offer the following ‒ Acute care hospital ‒ Family health practice (5) ‒ Pharmacy (2) Facility Locations Memorial’s Overall Geographic Footprint Images intentionally blurred 37

39 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. DischargesOutpatient Visits ALOSADC Memorial’s Utilization Saw a Decline from FY09 to FY10, but Is Projected to Increase in FY11 Note: 2011 data is annualized based off the first 9 months of FY Source: Memorial internal reports 38

40 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Cost versus Quality: How Does Memorial Stack up Locally/ Regionally? Note: Bubble size corresponds to Hospital FY09 Net Patient Service Revenue. Source: Commonwealth Fund, Ingenix, CMI Adjusted Cost per Discharge Versus Commonwealth Quality Ratings for Memorial and Its Regional Competitors 39

41 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Memorial and Controlled Entities Historical Credit Profiles Notes: (1): Annualized based on 10 month results. S&P Medians based on U.S. Not-For-Profit Stand-Alone Hospital Report for 2009 and Moody’s Medians based on Not-For-Profit Healthcare Medians for 2009 (both published in 2010) 40

42 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Phase III: Scenarios, Sensitivities, and Assessment of Independent Plan 41

43 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Organizational Competencies 42

44 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Facility Plan Memorial developed a master facility plan approximately four years ago The master facility plan contemplated a new state-of-the- art patient tower with all private rooms The estimated cost of the tower and other necessary renovation was approximately $100 million More recently, an alternative plan for renovating the current facilities, including the conversion to all private rooms, was developed with an overall cost of $34.5 million 43

45 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Sensitivities to Baseline 44

46 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Critical Success Factors Growth: Generate strong, consistent volume growth (inpatient and outpatient) and recapture market share, particularly commercially insured patients Low Cost: Leverage fixed costs to maintain low cost leadership position in the market Physician Initiatives –Infrastructure – Enhance physician infrastructure capabilities for employed physicians –Recruitment – Strengthen recruitment and retention including part-time specialists to meet market demand –Primary Care – Better leverage Memorial’s primary care network –Physician Network Rationalization – Effectively align physician capacity with market demand Quality and Patient Experience: Improve quality and patient satisfaction Competitive Facilities and Equipment: Maintain efficient and competitive facilities and equipment Access to Capital: Strengthen financial performance/ flexibility and access to capital Market Position: Leverage well-respected brands in the market and build greater scale and essentiality New Era Initiatives: Develop and implement initiatives to best position Memorial for effectively competing in new era (e.g., care management initiatives, IT, clinical integration) 45

47 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Phase IV: Evaluation of Strategic Options 46

48 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Partnership Structures MergerConsolidationSale/ Acquisition Change of Corporate Member Sale of Controlling Interest Joint Operating Agreement Sale of Minority Interest Affiliation Management Services Agreement Joint Venture Low High Degree of Integration Fully IntegratedLess Than Fully Integrated 47

49 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Ability to achieve criterion Scale: Low ( ) ………………………. High ( ) Memorial’s Critical Success Factors Less than Full Integration Full Economic Integration 1 Strategic Partnership Deliverables Growth Physician Initiatives Market Position Quality and Patient Experience Competitive Facilities and Equipment Low Cost Access to Capital New Era Initiatives Full Integration vs. Less-than-Full Integration 1 Not specific to a particular partner and may vary depending upon specific partner. 48

50 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Assessment of Potential Partner by Type and Organization Critical Success Factors Stand Alone Regional Not-for-Profit Academic Medical Center For-profit with Market Presence Community Hospital Consortium 1 Growth Physician Initiatives Market Position Quality and Patient Experience Competitive Facilities/ Equipment Low Cost Structure Access to Capital New Era Initiatives LimitedFairGood Ability to advance critical success factor: 49

51 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Critical Questions in Partnership Evaluation 50

52 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. Critical Questions in Partnership Evaluation Who will be a strong partner? –Service line strength –Physician infrastructure –Quality –Brand –Market position and presence –Corporate infrastructure –Financial capability –Information technology –Historical relationship –History of successful partnerships –Intellectual capital to support evolving healthcare environment What are the implications of operating as part of the System? –Cultural compatibility –Corporate and shared services –Charges for corporate services and overhead –Capital allocation process –Senior management and management reporting relationships –Impact on employees –Impact on physicians –Governance How does the proposal respond to the partnership goals and objectives? –Commitment to achieving the established goals and objectives –Valuation (if appropriate) –Transaction structure and implications Does a partnership enhance the likelihood of achieving the Organization’s long-term objectives relative to remaining independent? 51

53 HFMA Copyright 2012 Kaufman, Hall & Associates, Inc. All rights reserved. THANK YOU Q&A 52


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