Partnership necessary to mitigate risk in current health care environment, execs say
ST. JOSEPH — Knowing the business wouldn’t get any easier, directors at Lakeland Health decided the best route into the future was to pursue a deal with another health system.
The search narrowed earlier this year to what President and CEO Loren Hamel sees as a “fairly easy partner” in Spectrum Health, a large health system that ranks highly for clinical quality. As well, Lakeland had been doing business with Spectrum Health for years through clinical partnerships.
Those ties eventually led the two health systems to discuss a possible deal, which culminated this month when they signed a non-binding letter of intent. The two organizations will work toward a final agreement by October in which Spectrum Health will acquire the St. Joseph-based Lakeland Health, which operates three hospitals in Southwest Michigan.
A deal with Spectrum Health was “the most prudent strategy” for Lakeland, Hamel said.
“This puts new tools in the tool case for Lakeland. It gives us new opportunities to reengineer that value of the care that we provide,” he said.
Joining the Spectrum Health family would give Lakeland Health a greater ability to achieve scale, generate operating efficiencies and optimize costs during an era in which pressures on hospital operating margins are getting “progressively worse,” Hamel said.
In deciding to pursue a suitor, Lakeland Health directors considered a range of changes in the health care industry, Hamel said. They include value-based payments from insurers that base reimbursements on quality rather than volume, escalating labor costs, “outrageous” pharmacy costs, an aging population and growing rates of chronic disease.
Given those factors, the questions for Lakeland then became when to do a deal and with whom, he said.
In considering the future in an ever-changing health care environment, directors opted to pursue a deal now while Lakeland Health remains in good financial condition. The present headwinds have created “a cat(egory) 5 hurricane” that the health care industry faces.
“If scale is mission-critical (and) integration is inevitable, then when you’re strong, you want to make a choice that has the greatest chance of creating durable value to the community you serve. That’s why we’re making the choice at this time,” Hamel said. “Most health systems probably have also considered ‘what’s the canary in the coal mine? What’s the right time to do this?’ And probably some make those decisions clearly earlier than later.”
A Spectrum-Lakeland union would become the first merger of health systems in West Michigan since Bronson Healthcare’s January 2017 acquisition of South Haven Health System, which serves a market on Lakeland’s northern flank, and Metro Health’s merger into the University of Michigan Health System in December 2016.
Lakeland Health includes hospitals in St. Joseph, Niles and Watervliet, plus 46 ambulatory care sites, nearly 500 doctors and advanced practitioners, and 4,160 employees.
In the 2016 fiscal year, Lakeland Health’s hospitals in St. Joseph and Niles recorded total revenue of $403.5 million with net income of $38 million, according to the most recent available financial statement filed with the IRS. That compares with $399.5 million in total revenue and net income of $58.1 million in the prior fiscal year.
The organization’s Watervliet Community Hospital had $37.3 million in total revenue in 2016 with a net loss of $1.6 million, according to an IRS filing.
If the deal comes together, it would make Lakeland Health part of a much larger system that can work to drive administrative efficiencies, plus help to lure physicians to Southwest Michigan and build specialty medical services in the market, said health care consulta nt Mike La Penna of The La Penna Group Inc. in Grand Rapids.
“There are a lot of things Spectrum will punch up,” La Penna said.
Lakeland Health also gets the benefits of a heightened status and brand in becoming part of Spectrum Health, La Penna said. He likens it to Metro Health merging into University of Michigan Health, which is renowned for its quality of care.
That heightened status could help Lakeland retain patients within its market who may otherwise go to Kalamazoo, for example, if they need heart care or surgery, he said.
“It does give Lakeland a sort of prestige,” La Penna said. “Then maybe people don’t go to Borgess for their heart stuff.”
‘VERY NATURAL FIT’
A deal for Lakeland Health would extend Spectrum Health’s turf further across a broader swath of Western Michigan and into a new market. Expanding geographically and moving into the Southwest Michigan market “sort of makes sense” for Spectrum, La Penna said.
Spectrum Health acquiring Lakeland Health would follow years of long-standing ties between the two health systems. Lakeland Health is a member of Helen DeVos Children’s Hospital’s Partners in Children’s Health collaborative and has partnered with the Spectrum Health Medical Group for specialty services, including cardiovascular care.
Given the existing clinical connections between the two organizations, Spectrum Health President and CEO Rick Breon views the acquisition of Lakeland Health as “a very natural fit.”
Breon termed Lakeland Health a “very solid” and well-run system that shares similar clinical and corporate cultures with Spectrum.
“Over time, they felt comfortable with us and knew who we were, and we knew who they are,” he said. “We’ve been in long-standing conversations with a lot of organizations, and this is certainly one of them where we’ve always felt there was a lot of synergy between the two.”
Lakeland Health would become a division of Spectrum Health and a local board of directors would retain oversight of capital investments and philanthropy.
Retaining some level of autonomy was a “significant factor” in working out the letter of intent, Hamel said.
“The notion of working out a structure that created system-ness and some local autonomy was a preferred destination for us and a very palatable destination for Spectrum,” he said.
In past acquisitions, hospitals became part of Spectrum Health Hospital Group. However, Lakeland would become the biggest acquisition ever for Spectrum Health, which meant the deal required a different structure.
“You treat those a little bit differently,” Breon said. “They’re larger (and) they’re much more complex.”
The deal also would require state certificateof- need approval and review by federal trade regulators.
Since Spectrum Health and Lakeland Health’s markets do not overlap, Breon does not see any difficulty passing federal scrutiny.
DEALS ‘FAR FROM OVER’
Spectrum Health consists of 12 hospitals across the region, 180 ambulatory care and service sites, and 3,600 physicians and advanced practice providers, plus the second-largest health plan in Michigan, Priority Health. The health system in the 2017 fiscal year had total operating income of $5.68 billion with net operating income of $192 million.
The same forces that led Lakeland Health to seek a deal had Spectrum Health open to making another acquisition when an ongoing dialogue on clinical collaborations transitioned into something bigger. Even as one of the largest health systems in Michigan, Spectrum Health was open to attaining larger scale in the present environment, Breon said.
“One of the fundamental questions every health care organization has to answer is what size do you need to be to be able to take on the challenges of what health care is today and what it’s going to be tomorrow,” Breon said. “Right now, I think there’s a lot of uneasiness in the health care environment and people are trying to figure out where things are going, and almost every organization is having discussions, not so much of whether they’re going to merge, but where health care is going to and where their organization is going to fit.”
Because of that uneasiness, consolidation within the health care industry, including for hospitals, will continue as care providers seek larger scale to reduce the risk of the new reimbursement environment, he said.
“The M&A activity in the state of Michigan is far from over,” Breon said. “That’s still going to happen and organizations are going to be thoughtful about it and about where they’re going.”