The pace of consolidations will likely increase over the next several years, and an attractive consolidation model has surfaced—virtual mergers—according to the authors of a new Special Comment by Moody’s Investors Service.
Moody’s comment focuses on two broad types of virtual merger structures; in each, debt is separately secured by each partner:
- Parent-subsidiary model: one partner (the parent), usually larger, acquires or merges with a smaller hospital partner (the subsidiary). The parent becomes the sole corporate member of the hospital.
- “Newco” model: a new “super-parent” is created as the sole corporate member controlling both of the hospital partners.
(“Special Comment—Joined at the Hip: Not-for-Profit Hospitals Pursue Virtual Mergers; High Integration Links Bond Ratings Even When Debt Separately Secured,” Moody’s Investors Service, August 27, 2013)
Virtual mergers combine all or many strategic and operating functions of the consolidating hospital partners. Management, governance and operations are largely combined. However, debt obligations remain separately secured by the individual merger partners rather than consolidated, as in traditional merger or acquisition transactions. These virtual merger structures are typically considered legal mergers for anti-trust purposes because of the change in control, even though debt obligations are not merged.
Virtual mergers appears to be an attractive model for hospitals constrained from full consolidation by:
- Economic disadvantages; i.e., the existing debt structures
- Ownership structures; e.g., mergers between county-owned and private 501(c)(3) hospitals
- State regulations; i.e., legal restrictions regarding asset transfers to an out-of-state partner
Virtual mergers created to avoid the high costs of combining debt will likely become full mergers when a debt restructuring is economically beneficial. Those related to differences in ownership structures or state regulatory restrictions will retain their virtual model.
The Special Comment authors noted that virtual mergers are credit positive for smaller hospitals that join larger healthcare systems and that benefit from the reduced costs and higher revenue attained through a parent- subsidiary model. “The debt obligations and ratings are distinct, but a high degree of integration between the parent and subsidiary can result in a higher rating for the subsidiary than would have been assigned independently.”
They also said that larger hospitals are becoming similarly challenged by lower revenue growth and will seek growth through virtual mergers with similarly sized hospitals. “The impact on the separate ratings of larger partners is not a clear positive as it is with smaller hospitals joining larger systems, but rather driven by the individual credit positions of the partners and degree of integration.”
(“Special Comment—Joined at the Hip: Not-for-Profit Hospitals Pursue Virtual Mergers; High Integration Links Bond Ratings Even When Debt Separately Secured,” Moody’s Investors Service, August 27, 2013)
iProtean subscribers, you can read the full Special Comment from Moody’s Investors Service by going to either of the advanced Mission & Strategy courses, Affiliation and Consolidation Strategies Part 1 or Part 2, and clicking on the Resources tab, where a link to the article appears.
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