This is the first in an occasional series of roundtable discussions by Certified Turnaround Professionals (CTPs) on issues impacting the turnaround, restructuring, and distressed investing industry. In this installment, Ruediger (Rudi) Mueller, CTP; Robert D. Katz, CTP; and Edward J. Sanz, CTP, discuss some of the problems facing distressed hospitals. Mueller moderated the discussion.
Mueller: Our topic today is hospitals. That is obviously a very large topic area, so we will limit ourselves to a few key issues that distressed hospitals, and hospitals in general, are facing around the country.
We are looking at market issues. Do hospitals market themselves to the right audience, to the right local market? We are looking at financial issues. And we are looking at a couple operational issues, mostly scheduling and the huge black hole in hospital finances, emergency rooms. So we start with Ed Sanz, who will talk about the markets, and then continue with Rob Katz, who will talk about finances, and, last but not least, we will talk about operations.
Sanz: If you think about the origins of where hospitals are today, it goes back to the very structure of Medicare and Medicaid, and how providers have historically chased payments; that is, the services they provided were often determined by the payments that were set up to pay for those services. Also, there is a huge duplication of services in the market as hospitals have chased market share. That created a lot of overlap in the market. Although that has been mitigated by certificate of public needs laws at the state level, there’s still a long way to go.
The critical issue facing hospitals is that they are not responding appropriately to what their specific markets need. They are not identifying all the services that are required in their service area and are either being all things to all people, or else they are specializing too much and offering specialties for which there may not be enough support. You can look at the recent bankruptcy in Louisiana of the Louisiana Heart Hospital as an example of that.
I think that hospitals are also failing to understand their competition as well, in terms of geography and services. They’re adding and discontinuing services without really appreciating and pursuing affiliations and partnerships that could preserve offerings, but without all of the related capital costs and operating costs that go with them. I’m talking about not just specialties, but also fundamental things, such as inpatient versus outpatient beds, etc.
There was a University of South Carolina report on healthcare trends between 2003 and 2012 that found that healthcare coverage has increased, obviously because of the ACA (Affordable Care Act) and the expansion of Medicaid, subsidized premiums, etc. But there are fewer practitioners available overall, and many of those that do practice aren’t accepting Medicaid. So while you have more coverage, there is less access to care. That is especially true for children living in poverty and for people in rural areas.
That is the lead-in to the group that I think is the most affected and the most distressed: rural hospitals. They are facing significant distress from falling censuses. Rural populations are decreasing and income levels are falling, but they still have a very diverse population that is generally sicker, poorer, and older, and they have limited access to healthcare. Here are these hospitals with higher operating costs, but with reimbursement rates falling. They have more competition from larger hospital groups, especially huge mega hospitals, that are pulling patients away. They also have trouble attracting and retaining physicians and practitioners at all levels.
Southern rural hospitals make up the biggest portion of troubled hospitals, and it makes sense because more than two-thirds of them are in states without Medicaid expansion. There are fewer dollars available. That is the lay of the land as we see it now, with some of the issues and problems in defining and reacting to the markets that they serve.
Katz: It’s interesting, too, that obviously, because they’re rural, they’re harder to get to, and you can’t achieve the critical mass of patients, which makes it significantly more expensive to operate. And while there is more access to coverage, that doesn’t mean that people can afford the coverage/access.
Mueller: It appears to me that there is almost a two-way split between hospital marketing issues. In the rural areas, it seems that it is very hard for a hospital to get to the critical size to operate efficiently. In larger cities, it seems to be different. There, it appears that it is a failure of hospitals to read their markets and their competition and evaluate which specialties to go into and which specialties are already saturated or overserved in a given community. Does that sound about right, Ed?
Sanz: Yes. Even if you are successful at creating affiliations and partnerships and a network where you can cobble together all the services you need, to both of your points, it doesn’t necessarily mean it’s easy to get to. Access can still be tough, even if you can afford it.
Mueller: Let’s move on to the next topic. Rob, you wanted to talk a little about the financial challenges facing hospitals today.
Katz: The interesting thing is there is a plethora of money out there, though not necessarily if you’re totally distressed. Among private equity, asset-based lenders, and equipment financing, there are plenty of institutions where lenders are willing to finance these situations. Their creativity, ability, and appetite for risk will likely be proportional to their potential return.
One of the examples where we have seen issues was a hospital in Pennsylvania, where the state stopped funding reimbursements for indigent care for emergency room visits. So the company lost $5 million overnight, which forced it into bankruptcy. What we ended up having to do is restructure the bonds. When you restructure bonds, you have to find the individual bondholders and go through the trustees, so there is a mechanical process that makes it a struggle. Having said that, we were able to finance the accounts receivable and the other equipment by developing a plan to restructure and rework the hospital’s collections, its operations, and its efficiencies.
At all different levels of the capital structure, but a lot of times if you’re in distress, the crucial differentiator is: what is the plan for exiting? In today’s environment, patience is a key and an opportunity. That is still something that is desperately needed. People and institutions are beginning to take a different view. They are willing to work things out as long as they are going to be compensated for doing that. What we also found is that there are some financing organizations that are nonprofits and have the same mission as the hospitals.
We have worked with and are working with one organization that wasn’t a hospital but provided assistance to the incarcerated population in one of the Mid-Atlantic states. The organization’s CEO found a lender whose mission included funding entities helping that community. What better way is there to obtain financing than having a financing partner that has a similar mission and goal that the hospital does?
To me, a lot of it is about creativity, finding the right partner, and understanding the pressure points that that partner has. Those are critical. Whether it’s an asset-based lender with a revolving line of credit or someone who is financing the equipment, other than getting paid back, which is everybody’s goal, what are the pressure points, and how willing are they to work with the organization? Most lenders, don’t want to be on the front page of the local paper for putting a local hospital out of business, so there is plausibility for wanting to work though this situation.
We just worked in a situation where a company that specializes in purchasing distressed hospitals purchased a hospital. They put money back in to fix it up. They make a commitment to invest in the community over five years to keep the hospital open. It may be in a different format, way, shape, or form; they might have reduced some of the practices. But again, where is the vision, what is the execution plan, and who is going to help not only the organization but also the community to get there?
Mueller: I found, and please correct me if you see it differently, that in some hospitals there is also an issue on the cost side, which obviously contributes to financial distress, where you have physicians that prescribe, let’s say excessively, certain procedures that hospitals will not be reimbursed for. Have you observed similar issues?
Katz: It is hard to say, but what I’ve found with distressed hospitals is at times it can be about positioning and leverage. For instance, in a recent situation the purchaser had a plethora of doctor practices. If one doctor practice is trying to charge too much or trying to hijack the hospital, the buyer has other doctor practices at their disposal that are looking for variable income, so they’ll kick out the incumbent and bring in the others without missing a beat.
To your point, if you do a cost/benefit analysis, it’s like product profitability and customer profitability. Which doctor practices are your most profitable and most efficient? It’s not based on what they charge, it’s based on what they collect. That criteria lets you know who you want to keep and who you want to get rid of. It’s the old 80/20 rule.
Sanz: That is a great point. It’s like any great business. It’s knowing what you’re good at and trying to have a competitive advantage and not trying to be all things to all people. To your earlier point about lenders and hospitals trying to finance these things and work through all the investment options, that’s why it’s so important to know you’re good at certain things. If it’s a particular need in your community, you invest in those things. For other things that aren’t necessarily your strengths, you form affiliations with other providers and other hospitals, and you have referral networks. You can still offer the services, but you’re not investing in them and doing all of the things to burden your capacity.
Katz: On the front end, when you’re financing or looking to refinance, you really want to know who your partner is. It’s a cliché, but I always said when times are good, it’s really easy—everyone wants to lend or invest money. But you really need to know what their appetite is if things aren’t going well. How will they handle it when you hit a bump in the road, because everyone at some point will hit that pothole? When you’re in, it’s too late. It’s critical to understand that and talk to someone who has been in a workout situation with that lender. You want to understand what the rules and practices are when times are tough.
Mueller: Some of these issues that both of you mentioned were actually key to a successful turnaround that was nationally reported, Grady Hospital in Atlanta. This is arguably the Southeast’s best and most successful level one trauma center, and it was in deep distress. But the turnaround followed pretty much all of these steps in this conversation, and that has led to a very successful restructuring.
Let’s move on to operations. There are two areas in operations I’d like to touch on, although there are obviously many more. One is more short-term, what I would call a quick fix. The other one is a more strategic measure.
Regarding the quick fix, it never ceases to amaze me how many hospitals are still fairly inefficient at scheduling their staff. That leads to significant costs that are avoidable, both in terms of the number of people on duty at any given time, as well as the qualifications of the people on duty at any given time. Today, we can buy efficient scheduling software, available through a number of vendors, that can help us in large hospitals. The successful ones already do this.
I have seen small hospitals at the extreme where scheduling is done on paper and is based on preferences, which are given to people who have more seniority. This, however, is highly inefficient. That may lead at times to having much more staff on duty than you actually need to run the operation, and at other times, it is exactly the opposite. You’re running short, which leads to excessive wait times for patients in the hospitals and emergency rooms.
That is one issue, and it’s a fairly easy fix to get the right software. Give administrators the right training, and do not schedule a registered nurse for a job that a candy striper can do. Make sure you don’t have any people on staff that you do not need at any given time. Every day, every morning, typically, hospitals run a census of the number of people in the hospital, and that is the basis for determining how many people are needed and where they are needed.
Sanz: That’s what we do as CTPs. We try to look across not just this industry, but others, just like any business or industry. What you’re talking about is the commonality of knowing your strengths, knowing what you do, and continually reviewing what you offer. Your patients in your hospital are your customers, along with the physicians that you’re dealing with. It’s fundamental in following those metrics.
Katz: The other thing that is going to become more prominent in the coming years is called “bundled services.” If a hospital discharges someone and they get readmitted, the hospital is penalized on its reimbursements. I am a board member of a prominent senior care facility, and while they are relatively small, they are moving up in prestige because when their patients are transitioned, they have almost no readmission rates.
So how do you pick out, as Ed said, your partners and knowing that you won’t get charged back for readmittance? It’s an opportunity, again, to find your partners and work well together.
Mueller: That’s absolutely true. Moving on to the next operational issue, which is more strategic in nature, one of the bigger financial black holes in the hospital operation is the emergency room. Some hospitals around the country have realized that this is probably the least efficient way to handle nonemergency walk-ins. ERs are designed to handle serious emergencies that typically lead to admittance to the hospitals, such as injuries from car accidents and disasters, serious diseases, and so on. They are very inefficient when it comes to treating relatively minor things, such as someone who has the flu.
One issue is to keep the people who shouldn’t be seen in the emergency room out of the ER. What some hospitals have done, and it takes a little time and investment, is to develop walk-in clinics that exist parallel to the emergency rooms and are far more efficient at dealing with the minor cuts and scrapes, sniffles, sneezes, flu, and so on. They keep such patients out of the far more expensive emergency room.
There are now hospitals that are trying to set them up. Many are not setting them up in their own facilities, but in separate buildings, as satellites to their hospitals. They act as the first line of defense against more costly treatments, and they are able to deal with the majority of issues. They utilize nurse practitioners that can do a lot of things that physicians can do.
And, of course, with the emerging discipline of telemedicine, they can in the future also call in the physician without having that physician physically present. That physician may be able to handle several facilities simultaneously, rather than having to be physically present at a single facility. That is another area in which hospitals can become more efficient going forward.
Katz: I think the model of minute clinics is different. I was in one over Thanksgiving weekend, fortunately or unfortunately, and we were in and out and fully treated in about an hour and 10 minutes. People couldn’t have been nicer. They were looking to do it promptly, efficiently, and effectively, and they are usually now in places where they can offer additional services if needed. It’s a much different model than we’re all accustomed to.
Mueller: And that model can be quite profitable and therefore contribute to a hospital’s overall well-being. Hospitals in the past have been reluctant to venture out into these kinds of operations. What they really should do is embrace them and see them as profit centers, rather than insisting on their emergency operations that provide that 1½-hour service at probably a far higher cost factor than what it cost to treat you.
Sanz: When you think about it, it solves some of the issues of shortages with practitioners and physicians, because they are able to use nurse practitioners. The trend of using nonphysicians with physician oversight to perform services formerly provided only by doctors will continue, particularly in rural areas. There is a huge demand for convenience. This trend serves that need in the community and, as you said, gets rid of the overcrowding of emergency rooms and keeps costs down. That’s a great solution.