Mergers abound in Southland as health reform looms; survival provides impetus for flurry of consolidations.

Survival provides impetus for flurry of consolidations

Keeping track of the health care industry mergers in Los Angeles can be daunting these days.

Woodland Hills-based Health Net merged at the end of January with QualMed Inc. of Colorado. Burbank-based Summit Health Ltd. has agreed to be acquired by Nashville-based Ornda Healthcorp. Torrance-based Sunrise Medical Inc., the world's largest manufacturer of medical devices for home use, has bought two other companies in the past eight months, including its $132 million purchase of Pennsylvania-based DeVilbiss Health Care Inc. last July.

A proposed merger of Burbank-based UniHealth America and San Francisco-based Blue Shield of California fell through last year, but analysts said they wouldn't be surprised if both companies are involved in future mergers.

These are just a few of the deals that have either taken place or have been talked about as health care companies in Los Angeles join the merger frenzy that is sweeping the country. Indeed, if ever an industry was gripped by merger mania, it is today's health care business.

Companies of all sizes and in all facets of health care are casting about for merger partners. And, according to industry analysts, this is only the beginning. Mergers are going to be the industry's prescription for survival as America reinvents its health care system and federal officials push health care reform.

But the term "mania" may not be quite accurate because merging today is actually a pretty sane choice for many health care providers. Hospitals, doctor groups, drug companies and others that want to survive in the new health care world order will have to be bigger, more efficient organizations structured to deliver care in new and different ways, industry observers said. "Everybody's got their eye out right now," said Mike Dwyer, senior manager in the health care services group at accounting firm Kenneth Leventhal & Co. "Everybody is looking to combine either as a full-on merger or some sort of affiliate status as the first step to a merger."

Dwyer said the overriding reason for the mergers in most cases is survival. But Dwyer and other consultants advised that mergers are full of potential pitfalls. One of the most important considerations, they said, is making sure the corporate cultures mesh.

"If you have a religious institution acquiring a hospital that has been part of a secular system, you can get into some medical ethics issues about abortion and sustaining life that can have a very significant impact on whether the merger is going to work," said David Vena, chairman of the health care practices group at the law firm of Latham & Watkins.

A different kind of culture clash almost prevented the merger of Health Net and QualMed.

Don Prial, director of media relations at Health Net, said the company initially resisted QualMed's merger overtures because of the differences in the way the two health maintenance organizations traditionally billed for their services. Health Net has operated on the concept of "capitation," which means the HMO prepays medical groups a flat fee per patient per year. QualMed has used a fee-for-service approach in which providers are paid only for the services they deliver.

Generally, capitation is believed to work better in highly urbanized areas like Los Angeles, where average costs per patient can be estimated on the basis of large populations. Fee-for-service is utilized more in rural areas, where sparser populations make it difficult to establish reliable forecasts of average annual costs per patient.

When Health Net initially refused to merge, QualMed filed a lawsuit challenging the refusal. But the two companies later negotiated a settlement, and their merger became final Jan. 31 when the new corporate entity, Health Systems International Inc., began trading on the New York Stock Exchange under the symbol MQ.

Explained Prial: "As we were going back and forth between courtrooms, along came President Clinton and health care reform. So our two respective chairmen (Roger Greaves of Health Net and Dr. Malik Hasan of QualMed) said to each other, 'This is crazy. We're sitting here fighting each other over a legal point and national health care reform is going to march right by us.'"

Prial said the merged company now is "working on a way to successfully use capitation where it makes sense and use fee for service where it makes sense."

According to Vena of Latham & Watkins, health care mergers are unique because they involved complicated issues that don't arise in manufacturing or other industries in which mergers have been common for years.

Among the issues that set health care mergers apart are:

* Many providers are affiliations of non-profit corporations, meaning no money changes hands in a merger. What happens is that control over the nonprofit entity changes hands, and there can be significant differences in the operating policies of those merging organizations.

* Merging hospital chains must decide whose medical bylaws and accreditation procedures will take precedence.

* Management of merging health care companies must consider whether or not doctors at both institutions will be happy with their privileges under the new arrangement.

* If a service, a laboratory or some other hospital function is going to be consolidated or moved from one hospital to another, the reaction of the medical staff must be anticipated and appropriate accommodations made.

* The business practices of merging entities must be analyzed to make sure they are in compliance with state and federal laws against hospitals offering payments to doctors for patient referrals.

Explained Vena: "Normally, hospitals are surrounded by little clusters of joint ventures between the hospitals and the doctors to provide mutual incentives. Some of these skate very close to the lines of what's paying someone for a referral and what's there to promote economy and efficiency in the organization. "When you get mergers of entities," he said, "you can inadvertently back into problems that didn't exist when they were separate if doctors at one (entity) own an interest in another."

Vena said this aspect of mergers is going to get even stickier next year because of a new California law that will go into effect Jan. 1, 1995. Beginning then, he said, "There will be a very broad provision against doctors owning interests in joint ventures with hospitals for a whole range of diagnostic and ancillary services, such as radiation and chemotherapy treatments, lab services, prosthetic devices, durable medical equipment and prescription drugs." Even for the companies that do successfully merge, the battle for survival in the changing health care world will only be half won. They will still have to adapt to changing market conditions. One of the biggest changes will be the switch to outpatient care for a higher percentage of patients.

Julia Thomas, president and chief executive officer of the Westwood-based architectural firm of Bobrow-Thomas & Associates, which specializes in health care facilities, said the transition to outpatient care is well under way already.

"Fifty percent of surgeries are done on an outpatient basis today, and there are projections that the figure is going to go to 80 percent in the near future. You have to ask yourself, 'Who's going to be left in the hospital?,'" Thomas said. She said the change also raises questions about whether the physical facilities that hospitals now own will be appropriate for a health care delivery system that will be so much more outpatient oriented.

"Most of the capital that has been invested by these organizations, including the ones that are looking to merge, has gone into the development of inpatient facilities," Thomas said. "The question is going to be what to do with them.

"We're going to need to rethink what we should do with these existing facilities," she said. "A lot of these hospital chains that have merged have created a whole big number of hospital beds but haven't created the ambulatory care facilities, which is where health care is going."

Thomas added that the change is coming regardless of what happens to President Clinton's push for health care reform. Clinton's reform plan suffered a setback last week when the Congressional Budget Office ruled that it should be viewed as a new government program, not a private insurance plan as characterized by the Clinton administration.

"This is going to happen with or without the Clinton bill. The Clinton bill will mean universal access, but hospitals are radically downsizing already," she said. Although overall demand for health care is expected to rise with universal access being provided, the bulk of that demand will be for outpatient services. As a result, many hospitals are dramatically downsizing their inpatient capacities.

Although many of the mergers involve huge, high-profile hospital companies and HMOs, the trend runs through every facet of the industry.

At Torrance-based Sunrise Medical, for example, the focus has been on acquiring firms in the home health care arena, including DeVilbiss and a Florida company called Pulsair Inc. DeVilbiss is one of the world's largest manufacturers of respiratory products for home use and Pulsair, which Sunrise bought in January, is a manufacturer of liquid oxygen products.

Richard H. Chandler, chairman and chief executive officer of Sunrise, said the global market for home respiratory services is $750 million and growing at 11 percent per year. "Overall, there is an excellent match in our strategic directions and corporate cultures," Chandler said.

According to Leventhal's Dwyer, strategic direction is one of the important considerations for would-be merger partners because "health care providers are not going to be able to be all things to all people. So they need to decide just what they are going to be and plan their mergers accordingly."

The winners in the merger derby, he said, will be the companies that "prudently sit back and list out their strategic objectives and define very rational and timely business plans for implementing the merger, rather than trying to merge just for the sake of joining the bandwagon."