Featured Article Private equity’s lessons for evolving U.S. hospital business models

Some healthcare executives are seeking partners that can bring an infusion of capital to help them innovate and evolve.

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Private equity’s lessons for evolving U.S. hospital business models

The traditional hospital business model is on shaky ground. Not only are hospitals facing inflation from their own suppliers, they are also experiencing ongoing pressure to treat patients in the lowest-cost venue possible—often outside of hospitals. Meanwhile, payers are pushing for a shift from fee-for-service to value-based care. A business strategy based on filling beds is no longer viable.

The industry recognizes this: A recent Economist Intelligence Unit survey found that 58% of U.S. hospital executives say that their “business model will need to change substantially in the near term” in order to survive financially.

58% of U.S. Hospital Executives say that their “business model will need to change substantially in the near term” in order to survive financially.

Many hospitals face a need for strategic change, are open to new ideas and want flexible capital to implement the changes. From an investor’s perspective, it’s a perfect situation for an infusion of private equity (PE).

PE investors look for disruptive trends that they can exploit. Private equity asks, “Is there a change [in the hospital market] that I can accelerate and invest in?” says Nirad Jain, a partner in the PE and healthcare practices at the consultancy Bain & Company. Adds Elizabeth Campbell, principal at the PE firm LLR Partners: “Hospitals partner with private equity investors to drive innovation in terms of creating new types of players.”

This scenario is particularly relevant today: “New payment models have different capital, technology and operating environments,” says Ms. Campbell. “Hospitals partner with PE for both capital and expertise to make this transition”

Over the past decade, PE investors have helped chains implement at least four different tweaks to hospital business models:

  • Dominate the local market;
  • Roll up the back office;
  • Specialize to serve a narrower niche; and
  • Monetize unproductive assets.

The HCA model: Dominate the local market

The highest-profile PE investment in hospitals in recent years—the 2006 leveraged buyout of HCA, now America’s largest for-profit hospital system, for $33 billion by Bain Capital, KKR, Merrill Lynch Global Private Equity and others—shows how PE investment can drive the thinking around strategies to pursue.

"The big bet" [there], according to Mr. Jain, "was on being the category leader in hospitals in local markets because healthcare is very local. It was not the cause, but the accelerant of the idea that a provider that will be healthy over time has to have such a market position."

HCA frequently occupies this leading market position in the urban centers where its hospitals operate. In an environment where payers are looking to reduce hospital inpatient days, providers with a dominant market position are far more likely to survive.

The results speak for themselves: PE investors in HCA have already reaped handsome profits, and a substantial part of the recent M&A binge in the hospital sector involves establishing a stronger position in leading markets.

The RegionalCare model: Roll up the back office

Community and rural hospitals in the U.S. are struggling: 80 closed between 2010 and 2016, including 17 in 2016 alone. "Such hospitals will need to continue to exist," says Mr. Jain. "They need some way to do so and be healthy."

Some investors are creating hospital groups that cut costs by providing economies of scale purchasing and back-office functions. Apollo Management doubled the size of RegionalCare Hospitals by combining with Capella in 2016 to create RCCH Healthcare Partners. Since then, RCCH has bought two more hospitals and is on the lookout for more. Whether this strategy will succeed remains to be seen, but it could provide a model for sustainable rural and small community hospitals.

The SUN Behavioral Health model: Specialize to serve a narrower niche

In 2016 LLR Partners invested $34 million in SUN Behavioral Health, which runs community psychiatric hospitals. Ms. Campbell explains the attraction of the deal: "We are middle-market investors and typically not big enough to buy out a hospital," she notes. As a result, many PE firms focus on companies providing specific services, whether clinical or administrative, to hospital groups.

SUN’s specialty is short-term emergency psychiatric stabilization. As a standalone specialty hospital operator, SUN partners with general hospitals where emergency patients often end up in small psychiatric wards that struggle with demand. SUN’s hospitals also support communities that have lacked short-term emergency psychiatric facilities since the wave of deinstitutionalization in the 1970s and 1980s shuttered many large psychiatric hospitals.

"We are backing a team with a lot of expertise to provide a specialist care model that addresses a very large unmet need," says Ms. Campbell. Larger hospitals, as they increasingly partner with other healthcare providers, may consider adding specialist hospitals to their network, where useful.

The Capella, Ardent and Steward model: Monetize unproductive assets

Many hospitals are sitting on real estate that detracts from their focus on restructuring the business. Three recent transactions ranging in value from $900 million to $1.75 billion—between Medical Properties Trust and Capella; Ventas and Ardent Medical Services; and Medical Properties Trust and Steward—involve hospitals selling their real estate to specialized healthcare property funds and leasing it back. In doing so, they free up capital to accelerate their evolution into providers of care services rather than institutions bound by physical location and infrastructure.

The continuing, steady number of PE hospital deals shows that investors comfortable with risk still see routes to financial sustainability. The choices of PE investors can thus point toward innovative or evolving business models—an area of concern for all hospitals.


This article was written by The Economist Intelligence Unit and sponsored by Prudential. For more information call Prudential Retirement® at 800-353-2847 or visit Healthcare.PrudentialRetirement.com.

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