Healthcare reform: profits for lenders?

• Strategic affiliations and/or consolidations to achieve economies of scale in administration and purchasing—as well as depth in clinical assets (i.e., facilities and personnel expanded to a scale appropriate to serve the patient in a coordinated and comprehensive manner in regard to both primary care and specialized care);

• Rapid transformation of healthcare programs and networks for connectivity and patient-centered coordination across the spectrum of healthcare providers serving the patient (i.e., enhanced information sharing and care coordination among hospitals, nursing homes, rehabilitation centers, diagnostic facilities, physician groups, home health providers and other players). Such system transformations will include newly-evolving Accountable Care Organizations (an organization of health care providers that agrees to be accountable for the quality, cost and overall care of Medicare beneficiaries who are enrolled in the traditional fee-for-service program who are assigned to it.);

• Investment in information technology (telemetry and other electronic medical record infrastructure) to facilitate effective communication among providers pertaining to patient medical records, medications, and other treatment parameters;

• Physician recruitment and affiliation programs to replace retiring physicians and to staff-up for expected increases in patient volumes; and

• Renovation, expansion and/or replacement of hospital buildings and other facilities to satisfy increasing effective market demand (up to 32 million additional insured patients in the pipeline) and to achieve greater operating efficiencies, including more energy efficient construction.

Identifying the winning opportunities
Whether under for-profit or non-profit ownership, hospitals and greater healthcare systems are complex capital-intensive business enterprises with a focus on bottom-line cash flow. Some hospitals are profitable. Others are not.

Historical operating information pertaining to all hospitals in the United States is available through the American Hospital Directory on the web at www.ahd.com. Through this resource, bankers can quickly obtain useful information pertaining to any hospital in the U.S. This information includes historical gross patient revenues, net patient revenues, operating expenses, and bottom line EBITDA (earnings before interest, taxes, depreciation and amortization), as well as occupancy statistics (operating beds/patient days) and medical service statistics, both inpatient and outpatient.

Health systems with a proven record of profitable performance would tend to have good prospects for future profits if they incorporate the leadership-trends and best practices itemized above.

Hospitals that have not performed well in recent years may or may not have turnaround potential.

Internal factors leading to or contributing to the financial distress of a hospital or health system may include dated/obsolescent facilities; a mix of healthcare services which is out of line with market demand; excessive cost structure; and human relations issues (conflicts between hospital management and physicians).

External factors leading to or contributing to the financial distress of a hospital or health system may include increased competition via new hospital entrants/players in the market; introduction of newer more appealing hospitals or other medical facilities by one or more existing competitors; increased competition from outpatient providers (surgery centers, diagnostic centers, urgent care facilities); decline in customer/patient population; decline in customer/patient income levels; decline in third-party payor reimbursement rates due to changes in government policy/regulation, etc.

In some instances, the implementation of leadership-trends and best practices and related strategic investments in clinical programs and facilities can present attractive opportunities for turnaround and profit. Indeed, these sorts of situations are the acquisition targets of for-profit hospital corporations seeking to buy low, turn the facility around, then profit on the upside. However, these are higher-risk situations and any bank loan underwriting should be structured accordingly.

Security interests and property valuations
In general, the healthcare sector has tremendous potential for profit, particularly well-run healthcare providers. However, loan underwriting as to any particular hospital or healthcare system requires careful due diligence.

Hospitals and greater healthcare systems are business enterprises composed of three different asset classes. These are real property (property rights related to real estate); tangible personal property (furniture, fixtures, equipment); and intangible personal property (proprietary business models, business contracts, systems in place, staff in place, goodwill, etc.).

Although banks tend to focus on hard assets for security interests, the market values of those tangible assets are interrelated to market value of the greater going concern, including intangible assets and business elements related to the hospital or health system.

To optimize value of all asset classes, the physical facilities should be modern and in line with current market preferences/standards—and the intangibles should reflect effective management, well-negotiated contracts, functional systems, good relations with personnel, good customer service experiences, a good media (public relations) profile, and business plans including implementation of leadership-trends and best practices.

If a hospital has ineffective management, poorly-negotiated contracts, dysfunctional systems, etc., then those circumstances may create stigma or obsolescence resulting in serious devaluation of the tangible assets, real and personal.

To maximize potential profits and to secure its position, a bank will want to look for optimized value situations or at least situations that can be credibly moved in the direction of optimization of the overall hospital/healthcare business enterprise. From a financial standpoint, optimization boils down to positive cash flow. The primary cash flow of interest in healthcare is potential EBITDA. In instances where financial performance is unstable or reflects extraordinary items skewing recent operating results, emphasis in financial analyses may shift to consideration of net patient revenues (i.e., gross patient revenues less contractual adjustments).

Effective market demand for healthcare is expected to increase. Healthcare providers are now positioning to dramatically transform facilities and systems. This transformation is and will be increasingly capital intensive presenting excellent lending opportunities.