Merging Two Centers – Can it Solve Certain Problems?

The specific situation that this article principally focuses on includes an initial multi-specialty center that

1. had been open for 20 years;
2. was owned 70 percent by physicians;
3. had many physicians which had ownerships in other centers, and
4. was short on capacity.

This center also enjoyed a relatively long track record of success and distributions.

The second center

1. was a newer, multi-specialty center;
2. included many of the physicians from the first center;
3. worked principally on an out-of-network model; and
4. had, to date, enjoyed limited financial success.

The market was also clouded by a local hospital preparing to open a new joint-venture ASC.

The initial center had many challenges, including:

1. a need for additional capacity;
2. concerns about divided loyalty amongst its physicians; and
3. competition with the new hospital joint-venture ASC.

It was also in the process of restructuring its own management company relationship.

The first center evaluated several different options. These included adding an additional operating room, attempting to improve operational efficiency and examining relocating the surgery center entirely. However, it was concerned about expending a great deal on money on expansion or relocation if it did not have a greater sense of loyalty from its physicians and stronger contractual relationships with them. It also examined, as a compliment to expanded capacity, a resyndication to expand physician ownership, efforts to enhance payor contracts, adding additional services and enforcing safe harbor rules.

The center, in addition to facing decisions as to whether to expand and how to handle contractual issues with its physicians, was looking at potentially restructuring its partnership. This would include enhanced management efforts, converting from a partnership to an LLC, creating a new operating agreement that was more up to date and removing certain barriers to entry for physicians.

The center decided to focus on the specific option of merging with the other surgery center. This allowed it, as part of the merger, to both add the capacity it needed (and add physicians) and to restructure its operating agreement to include both sets of physicians with stronger contractual requirements. The parties, as part of the merger, had to determine the respective values of each center and determine how ownership would be comprised after the transaction. Further, the parties had to examine how they could cluster their cases and reduce total overall staff time while taking advantage of the improved capacity. Finally, the centers agreed to a management relationship with a national management company that would own part of the center and help steer the venture going forward.

The benefits of this merger include the following:

1. Merger of both centers resulted in a projected reduction in labor costs per case of more than $250/case.
2. Merger added needed capacity to the first center, resulting in capital avoidance associated with expansion of $2 million.
3. Management of both merged centers was now performed by a consolidated management team, further reducing operating costs.
4. The national management company’s influence relative to payor contracting has improved reimbursement on several critical payor contracts.
5. Projected savings associated with supply chain management were significant.
6. The merged centers became better positioned to compete with the hospital and its ASC.

This case study really examines a situation where centers were merged to expand capacity and address a few other challenges. The alternative type of merger, which we now see more and more often, is the type of merger where two centers are merged together with the intent of clustering more cases over a single space. In this situation, instead of expanding capacity, the two centers close down the operations at one center and work to decrease fixed cost per case. This can be a very successful strategy where there is significant capacity at one center to handle twice as many cases or at least the cases that would come from the second center.

The financial analysis as to whether such a merger will make sense in these situations starts in the following manner:

1. Center One owns 100 percent of an ASC which currently earns $1.5 million per year.
2. Center Two’s shareholders currently make $500,000 per year and own 100 percent of Center Two.
3. After the deal, Center One’s shareholders will own, e.g., 75 percent of the combined entity. In short, can there be a reasonable chance that the 75 percent ownership will generate more than $1,500,000 a year?

The shareholders must ask themselves the following questions:

1. What are the risks and challenges to continuing to earn $1,500,000 a year, ($2,000,000 overall)?
2. Are there significant cost savings or other synergies that make it is likely that the combined centers will do better than $2,000,000 in net income?
3. Will the contribution make it easier to recruit physicians or improve managed care contracts?
4. Are there other risks, such as loss of key doctors or reduced reimbursement, that need to be considered?

To answer these questions and move forward with the transactions, here are steps to consider:

1. Examine combined enterprise and develop combined business plan.
2. Assess respective values and negotiate terms of combination.
3. Enter into letter(s) of intent.
4. Provide private placement memorandum or disclosure documents to all holders of shares.
5. Assess consents needed to restructure partnership at a state- and a third-party-contract level.
6. Assess the need to buyout certain partners as part of the combination.
7. Set a closing date

We believe that these types of mergers, particularly the second type where people are trying to cluster more cases over a single set of fixed costs, will become increasingly common over the next few years.

Authors: Tom Yerden is the CEO of TRY Healthcare Solutions. You can contact him at TYerden@aol.com . Contact Scott Becker at sbecker@mcguirewoods.com This e-mail address is being protected from spam bots, you need JavaScript enabled to view it or (312) 750-6016.

Note: Look for Mr. Yerden and Mr. Becker as speakers in an upcoming ASC Communications audio conference discussing mergers and acquisitions.