Modern Healthcare
Another Cost of Capital
Cash Infusion Can Mean Survival for a Hospital, but Also Loss of Independence
By: Melanie Evans

When Lenox Hill Hospital in New York City joined a larger health system last year, it did so saddled with debt, financial losses and a chronic need for capital investment.

The 483-bed hospital became the only Manhattan outpost of North Shore-Long Island Jewish Health System after its acquisition. No longer solo, the hospital gained access to cash for upgrades and other investments that had been delayed for years. That infusion, however, also brought an end to the hospital's independence and the ability to decide how capital will be spent.

“To us, from a business perspective, if we didn't have the principal to invest in equipment, technology and infrastructure,” the hospital could not hold onto or recruit quality physicians, says Michael Breslin, who was executive vice president and chief financial officer at Lenox Hill prior to the deal. “That eventually leads to a death spiral.”

As the number of hospital deals has grown, more executives, directors and trustees of capital-starved hospitals are struggling with a similar trade-off between capital and control. Capital has been a notable factor in recent deals for stand-alone hospitals and some small systems. For example, 248-bed Community Medical Center, Scranton, Pa., received a pledge of roughly $158 million from Geisinger Health System in an acquisition deal announced last month.

Hospital merger and acquisition activity, slowed by uncertainty during the debate ahead of the 2010 health reform law, has since accelerated to reach the “fairly strong” levels not seen since the late 1990s, says Sanford Steever, who monitors healthcare dealmaking as the editor of Irving Levin Associates' Health Care M&A Report.

From January until the end of June, prospective hospital partners announced 56 deals, and of those transactions, 32 were announced in the second quarter, according to Irving Levin research.

Capital allocation “almost always” factors into deals made by LifePoint Hospitals, says Jeff Seraphine, president of LifePoint's division that oversees acquisitions. LifePoint and Duke University Health System launched a joint venture in February to acquire North Carolina hospitals.

As the system evaluates a deal, its engineers and experts in information technology and finance comb over prospective partners while executives meet with an acquisition target's board members, physicians and others to review strategic goals and capital plans, he says. LifePoint typically makes a 10-year capital commitment after the parties agree on a strategic plan, he says.

LifePoint will commit significant capital when executives believe the cash infusion to be a good investment, he says, citing LifePoint's acquisition of 100-bed Clark Regional Medical Center in Winchester, Ky., last year after the system agreed to spend $60 million to build a replacement hospital.

At Lenox Hill, board members and executives believed the hospital “would survive and thrive if we could get out of the morass of being unable to generate profit that was there,” Breslin says. Committed capital from potential partners was a “top, top priority” along with compatible culture and medical staff, he says.

Financial losses since 2005 forced Lenox Hill to curb spending and scale back capital plans to preserve cash. Operating performance improved after the hospital joined North Shore-LIJ in May 2010.

Lenox Hill Hospital ended last year with net income of $8.1 million after losing nearly the same amount the previous year and a net loss of $14.3 million the year before that, financial records show.

Prior to the deal, capital invested in Lenox Hill fell $10 million short each year during the last half of the past decade, Breslin says. Each year, executives depleted funds set aside for unplanned emergencies and Lenox Hill's list of capital project priorities grew. “I knew deferred expenses would come home to roost,” he says.

Turnaround efforts helped to narrow losses until the Great Recession, “then the world changed pretty dramatically and what became evident to the board was that we didn't have the wherewithal to take unexpected hits” without a larger, stronger partner, he says.

Breslin, now North Shore-LIJ vice president of managed care, no longer debates or decides how much to invest in new technology, devices or renovations at Lenox Hill. He acknowledges the trade-off between capital access and control, but says Lenox Hill officials carefully vetted prospective partners on their capital strategy and commitment and came away satisfied North Shore-LIJ would invest in technology and promote quality.

North Shore-LIJ is expected to pour $150 million into Lenox Hill through 2013.

System executives estimated capital spending would total $125 million to $175 million as they evaluated Lenox Hill prior to the deal, but “until you get in there and live with the facility for a year” its not clear how much will be needed, says Mark Solazzo, executive vice president and chief operating officer for North Shore-LIJ.

The newly acquired hospital's most significant needs rank highly among projects seeking capital across the system, Solazzo says. Yet the struggling hospital cannot contribute to the system's overall margin to help finance capital investment. For other hospitals across the system, that may mean other projects must wait. “They never drop off the list, but priorities change,” he says.

Roughly half of the system's 300 capital projects are under way or are in preparation, he says. Executives review projects each quarter and adjust priorities according to need, he says. “There's always winners and losers.”

North Shore-LIJ, based in Great Neck, N.Y., owns 11 hospitals. The system, which last year posted revenue of $3.4 billion, budgets for a margin of 3% to support its capital projects, Solazzo says.

Spending for information technology, device upgrades and repairs, construction, renovation and maintenance is projected to total $3.1 billion through 2015, with roughly $487 million for IT.

“It's always a balancing act of the needs,” Solazzo says. “You will always have more needs than you will have resources.”

North Shore-LIJ swiftly invested $15 million to upgrade Lenox Hill equipment, he says. North Shore-LIJ is expected to invest another $75 million to renovate Manhattan Eye, Ear & Throat Institute and $75 million in the upgrade and expansion of Lenox Hill Hospital's operating rooms, cardiac catheterization laboratories, as well as pediatric and obstetric units, Solazzo says. Lenox Hill and Manhattan Eye, Ear & Throat merged in 2007.

“Lenox has seen more capital than it has in a long time,” Breslin says.