“Hospitals are facing higher reimbursement pressure”
How Hospitals Can Pursue Acquisitions and Thereby Improve U.S. Healthcare Quality.
Apr 22, 2015
The sea change in the U.S. hospital market brought about by the Affordable Care Act is pushing healthcare companies to find new ways to operate more efficiently and achieve economies of scale. This has led them to pursue acquisitions and to invest in medical equipment and IT with the aid of specifically tailored financial instruments, as James Gelwicks of the New York based Healthcare Finance Group (HFG) explains.
James Gelwicks, head of Capital Markets for the middle-market lender Healthcare Finance Group (HFG), is helping healthcare providers grow by lending and arranging a variety of large loans using specifically tailored financial instruments. Siemens Financial Services has collaborated with HFG on several of these financing strategies.
In this interview, he explains how hospitals can leverage the asset-based approach in particular to overcome financial challenges, and thereby eventually improve the quality of patient care.
Mr. Gelwicks, what are the biggest financial challenges for U.S. healthcare companies currently?
James Gelwicks: There is a tremendous amount of change in the healthcare marketplace. Hospitals are facing rising reimbursement pressure because of the Affordable Care Act. For example, reimbursement is being based on new quality metrics, such as readmission rates, as well as the more traditional diagnosis-related categories. Also, many states are using reimbursement rate adjustments to push providers toward less costly alternatives, such as home care.
What are the consequences?
Gelwicks: We see increasing competitive pressure among U.S. hospitals, leading to higher technology expenditures, as well as to increased merger and acquisition activity. To be properly reimbursed, hospitals must meticulously align diagnosis and new treatment codes, which has triggered the need to upgrade software and add staff. In addition, in an arena where the government’s decisions on hospital reimbursement dramatically affect the hospital’s variable margin, one way to increase profitability is to increase a company’s scale.
Could you explain some of your financing products?
Gelwicks: Some of HFG’s lending products are based on the assets of a company, others on its cash flow. Asset-based loans are backed by receivables or other hard collateral, such as inventory, whereas cash-flow loans are based on the projected future cash flow of a company. Also, equipment leasing is gaining importance as a lending product. Siemens Financial Services (SFS) has worked in conjunction with HFG to provide some of these products.
Case Study 1: Lowering interest costs through an asset-based line of credit
A specialty pharmacy company engaged Healthcare Finance Group (HFG) to arrange a $150 million asset-based revolving line of credit. The company had underperformed for some time. While it reported high revenues, it was hampered by relatively low profit margins.
According to James Gelwicks, head of Capital Markets for HFG, in this situation a large asset-based line of credit was the perfect instrument. These loans are backed by receivables and inventory – in this case, prescription drugs – and the company was able to borrow more than it could have if the loan had been based on projected earnings.
The company had previously borrowed to make acquisitions and was able to refinance that borrowing with the new asset-based credit line at a lower interest rate. Siemens Financial Services purchased $25 million of HFG’s share.
Case Study 2: Acquiring underperforming hospitals and restoring their profitability
A large for-profit healthcare company, currently with hospitals in nine U.S. states, wanted to purchase several underperforming hospitals and restore them to profitability. The company worked with HFG to structure a $475 million facility comprised of a $250 million term loan to acquire these hospitals and make the related capital expenditures, and a $225 million asset-based revolving line of credit for working capital and to upgrade the existing technology at these hospitals.
Healthcare Finance Group (HFG) acted as the sole lead arranger for this transaction involving 19 banks and finance companies. Siemens Financial Services committed $60 million toward the facility and also provided other financing to assist in the purchase of new state-of-the-art equipment from Siemens Healthcare. In the first year, the healthcare company used the financing to acquire five hospitals and were able to improve the quality of care for patients in those hospitals.
One area of improvement has been in the upgrading of medical equipment and overall infrastructure through $10 million to $30 million of capital expenditures per hospital. This equipment and other system upgrades are being used for several purposes such as reducing the wait time in the emergency room (ER), which results in higher satisfaction for paramedics and patients, as well as higher ER throughput. Last year, 13 of the company’s hospitals were ranked “Top Performers on Key Quality Measures” by the Joint Commission, the industry accreditor.
What are the respective advantages of these loan products?
Gelwicks: Companies are usually able to increase their overall leverage by adding an asset-based loan (ABL) to their capital structure since these loans are based on current assets and not on the overall company performance. The ABL typically carries a lower rate of interest than a cash flow-based loan because the risk for the lender is lower. This makes the ABL more suitable for companies with lower margins or inconsistent earnings. Cash-flow loans, on the other hand, are common for companies with higher margins.
The use of proceeds, or the purpose of a loan, is also important in deciding whether to use a revolving line of credit or a term loan. With a revolver, you borrow money when you need to, pay it back as funds come in from your customers, and then re-borrow when needed. You only pay for what you need. This loan type is used for working capital and short-term needs. Term loans, by contrast, are generally used for long-term investments, like an acquisition or the purchase of a large piece of equipment. Some of our clients combine asset-based revolvers with cash-flow term loans to secure the benefits of both products.
How do these products affect the financial performance of a healthcare provider?
Gelwicks: Every company can be more efficient and more profitable if its cost of financing is lower. Profitable hospitals can then attract and retain better staff, buy better equipment, and eventually improve the quality of patient care.
About the Author
Norbert Kuls is an award-winning business journalist based in New York. For more than a decade he has covered U.S. financial markets and banking as a foreign correspondent for two major German newspapers, Frankfurter Allgemeine Zeitung and the business daily Handelsblatt. He has also served two years in the healthcare field as a paramedic in Germany.