ACA Reshuffles the Deck

Strain from the patient increases and reimbursement delays expected from the Affordable Care Act (ACA) are causing some health care providers to turn to M&A. (For more, see the video below with Jeff Swearingen of Edgemont Capital.)

The ACA, which was passed in 2010 and began open enrollment in October, is having significant effects on the health care industry, and many middle-market physician groups are using M&A to cope with the more taxing consequences of the new rules. The increased rate of physician group mergers began before the implementation of the ACA, but experts agree that the new law has amplified the trend.

"Consolidation activity has been accelerating for years now, driven by changes in reimbursement and changes in the rate of the insured," says Joe Russo, director at Siemens Financial Services Inc. "Now, the ACA is a factor influencing behavior by hospitals and physicians."

Under the new rules, companies are joining together to create accountable care organizations, or ACOs. ACOs are networks formed by groups of coordinated health care providers that care for a group of patients, including a minimum number of Medicare patients, that allows them to receive bonuses for keeping costs down. An ACO is accountable to the patients and third-party payers for the quality, appropriateness and efficiency of the care it provides.

"One of the things that you're seeing in the marketplace is the movement towards integrated health delivery systems," says Russo. "A hospital or physician organization may be trying to take care of a patient for the entire lifecycle, and I think that is part of what is driving some of these hospital entities and physician entities together."

Companies are trying to create efficiencies; take costs out of the system and make health care more affordable, according to Anthony Casciano, senior vice president at Siemens.

"We've seen both hospitals and managed care plans make initial forays into acquiring physician groups or physician management groups in an attempt to create, in the case of the hospital, what is called an integrated delivery network, and for managed care trying to create effectively the same type of thing," says Jeff Swearingen, managing director at health care focused investment bank Edgemont Capital Partners LP, headquartered in New York.

"It's not a surprise that physician practices are at the leading edge of this consolidation trend," says Daniel Lepanto, a managing director at health care focused investment bank Leerink Swann & Co. in New York. "They were the early movers in this trend."

Sunrise, Fla.-based Mednax Inc. (NYSE: MD) has been picking up anesthesia and pediatric physician groups for years. In 2013, the company announced more than 10 deals for neonatal and anesthesia-services groups. Those transactions include the health care company's acquisition of Dayton Newborn Care Specialists Inc. in October, Northern Westchester Anesthesia Services PC in September, Sanjay P. Patel MD PA in July, and Anesthesia Group of Onondaga PC in June.

"A lot of what you have seen with the strategic buyers is more of the local dynamic playing out," says Swearingen. Of Mednax's 2013 acquisitions, for example, two were in New York, four were in Texas and two were in Tennessee. The company also made one acquisition in Georgia, adding on to the two Mednax acquisitions in the state in 2012.

In October, Heartland Dental Care LLC expanded by buying My Dentist Holdings LLC. The Oklahoma City-based target has 55 dental affiliates in Oklahoma, Missouri, Texas, Kansas and Arkansas that provide dental services, orthodontics and oral surgery.

Also in October, U.S. HealthWorks acquired the Urgent Medical Care center in Pompano Beach, Fla., which gave the buyer 14 care centers in Florida.

In September, Kindred Healthcare Inc., a Louisville, Ky. -based health care company, sold 16 health care facilities that were outside of its designated 21 integrated-care markets. The locations were picked up by Vibra Healthcare LLC, and they include 14 transitional care hospitals, one inpatient rehabilitation facility and one skilled nursing facility.

Building a presence in a geographic area is common for health care groups. "I do think we'll see the acquisition of different primary care groups to gain scale and mass and have the depth of presence within a region to offer the capabilities that are required under the accountable-care rules," Swearingen says. "It's going to be interesting to see if there's a role for private equity in that."

In October, ATI Physician Therapy bought North River Physical Therapy, a Chattanooga, Tenn.-based company with eight clinic practices. ATI provides orthopedic rehabilitation services through more than 250 clinics in Illinois, Indiana, Wisconsin, Michigan, Ohio, Maryland, Pennsylvania, Delaware, Georgia and Tennessee. ATI is backed by Denver investment firm KRG Capital Partners.

Private equity groups typically focus on picking up hospital-based specialties, such as anesthesia, emergency room and radiology practices, Swearingen says. "Their intent there is really to make a platform investment and then add on to that organically and through add-on acquisitions; to assemble a regional or national presence, with the intent to sell to a strategic or to a larger private equity firm."

New York private equity firm Bregal Partners acquired US Community Behavioral LLC, a community-based behavioral health organization, in September as a starting point in the community-based behavioral health sector. In October, Bregal acquired ReMed Recovery Care Centers LLC as the first add- on acquisition for US Community Behavioral.

Community behavioral health has gotten private equity interested, says Bregal managing director Robert Bergman: "I think that is largely a function of increasing demand and reasonably stable reimbursement."

For the targets, private equity investment can mean the capital to update technology. "With the ACA there are a lot of new requirements for IT investment and data capture through electronic records. That requires capital, and private equity is there and has the ability to provide," says Russo.

Mergers may also give physician groups more leverage. "Physicians are looking to increase their size to gain efficiencies of scale and negotiating power with the payers," Russo says.

"Physicians are smack in the middle of patients and providers," says Curtis Lane from MTS Health Investors LLC, a health care focused private equity practice headquartered in New York. Lane attributes the deals to an evolution of the market and says that the ACA helps define how companies might combine.

MTS' portfolio includes AeroCare Holdings Inc., an Orlando, Fla.-based company that provides respiratory therapies; Alliance Healthcare Services, which provides diagnostic imaging services; and Fairfield, Ohio-based testing laboratory DNA Diagnostics Center.

In December, the firm made an investment in Edison, N.J.-based Vital Decisions LLC, a provider of counseling programs to patients with advanced illnesses. In April 2012, MTS recapitalized Florida Gulf-to-Bay Anesthesiology Associates LLC, a Tampa-based anesthesia service in Florida and Indiana.

Sheridan Healthcare Inc., a Sunrise, Fla.-based physician-services company, announced affiliations with three anesthesia practices in February: Rahway Anesthesiologists PA, Select Anesthesia and Pain Management Group PA, and Tri-County Pain Management PA. In October 2012, the company acquired Imaging Consultants of South Florida, a radiology service for Florida hospitals.

M&A is also coming from the hospital side, as hospitals use deals to create hospital systems for cost synergies and try to make sure they have enough physicians to meet increased demand, experts say.

"There are cost synergies for a system versus an independent hospital," Casciano says. "Margins pressures will force hospitals to make strategic decisions, of which mergers and acquisitions are a consideration. Trends seem to suggest that this will be happening."

Hospitals also need to make sure they are aligned with enough physicians to meet an increase in patient demand, Russo says.

Ryan Tate, vice chairman of the Integris Canadian Valley Hospital in Yukon, Okla., says the hospital has made several deals to bring new care to the network so it can refer its patients to those practices. In November 2011, Integris bought Plaza Medical Group, a cardiovascular specialist practice. "If you're not merging or acquiring in that area, you're leaving yourself pretty well open," says Tate.

In September, Prime Healthcare received a $475 million loan from Healthcare Finance Group, a subsidiary of Fifth Street Finance Corp. (Nasdaq: FSC), which it plans to use for acquisitions. The loan includes a $225 million asset-based revolving credit facility and a $250 million senior-secured term loan. Ontario, Calif.-based Prime plans to use the term loan to close deals that it has under asset purchase agreements.

Prime Healthcare operates hospitals in California, Kansas, Nevada, Pennsylvania and Texas. The company acquired Providence Medical Center, based in Kansas City, Kan., and Saint John Hospital in Leavenworth, Kan., in April.

In June, Tenet Healthcare Corp., a Dallas health care delivery system that operates through a network of hospitals, made a deal for hospital operator Vanguard Health Systems in Nashville, in an effort to grow into new markets.

In July, Community Health Systems Inc., the second largest U.S. hospital chain, agreed to buy Health Management Associates, a community hospital operator, for $3.9 billion. Also in July, Mount Sinai Medical Center and Continuum Health Partners planned to merge to form Mouth Sinai Health System. The deal was intended to increase efficiency and expand access to health care in New York.

"There is no question that the future holds many challenges for health care providers here in New York and across the country," said Steven Hochberg, Continuum's chairman, in a company statement. "The new entity created by bringing together the clinical and administrative excellence of Mount Sinai and Continuum will help provide us a position of significant strength and resourcefulness to meet these challenges."

Acquisitions allow hospitals to evolve into hospital systems with geographic concentrations, which should make care coordination easier, drive up quality and even out costs, according to James Boylan, senior managing director at Leerink. "If the hospital systems buy out doc groups, you will start to see care being coordinated more effectively," says Boylan.

For hospitals, M&A is really about the ability to negotiate favorable rates with the payers. "If you are bigger, your relationship is different than if you are a small or mid-market hospital," says Casciano.