Assessing Financial Performance in a Merging Acquisition
Mergers are a common occurrence in the corporate world. A merger between two companies usually means one of two things – one company consumes another by adding its brand, production facilities, assets, potential markets, and employees to their own, or the companies merge as equals to create a completely new entity. The purpose of any merger is to maximize profits, secure new markets, acquire selling power, and increase the strength and profitability of the dominant company. However, in some cases, a merger is organized with the intent to monopolize the market, escape a stockholder reform initiative, or protect the existing board of directors from any potential risks to their jobs associated with other mergers. The three main reasons for a merging acquisition are as follow (Harris & Johnson, 2016):
- Product diversification. A large corporation that is looking to expand its portfolio of products may be looking to merge with a company that has a name to itself and offers a different set of services to the market.
- Expansion towards a new market. Instead of starting anew in a completely different environment, a company may choose to merge with a local enterprise that could be refitted to produce similar products or services.
- Financial positions improvement. One company may choose to merge with another in order to have access to better sources of financing, as well as to improve debt and equity ratios.
Merging is not uncommon in healthcare. In the USA alone, a total of 98 hospitals had merged by the end of 2013. The number of merges registered in 2014 stands at 94 (Harris & Johnson, 2016). The reasons for merging in healthcare are somewhat different from merges between corporations. In the hospital industry, merging is conducted with the purpose of improving the quality and efficiency of healthcare while simultaneously decreasing costs and making healthcare more accessible to patients. Nevertheless, financial drivers remain an important part of merging acquisitions in healthcare. The purpose of this paper is to assess the financial performance in a hypothetical merger between Jackson Memorial Hospital and its potential competitor in Miami-Dade, which is the University of Miami Hospital.
Ratio Analysis
In order to assess the profitability trends of both hospitals prior to merging, several key ratios need to be evaluated. These ratios are the Current Ratio, Net Patient Revenue, and Net Income. It is also important to analyze investments, as they can serve as a primary motivator for merging. The Current Ratio represents the organization’s ability to pay off its short-term debts. Net Patient Revenue represents the average revenue the hospital receives from a patient. Net Income represents how profitable the organization is. According to the financial statement of Jackson Memorial Hospital, its ratios are as followed (“Public health trust,” 2014):
- Current ratio: 1.05 (Good)
- Net Patient Revenue: 100,529 (Good)
- Net Income: 73.4 million dollars. Compared to the previous fiscal year, Jackson Memorial Hospital suffered a severe drop in net income, as in the previous year it was 132.1 million dollars. However, the hospital remains profitable.
- Investments in JMH have remained stable and did not decline in comparison to the previous year.
Overall, despite the fall in net income, JMH remains an attractive venture for investors and has a decent prospect for the following year. Currently, it is mitigating expenses by halting its hiring processes while striving to retain existing employees.
Miami University Hospital, on the other hand, has been seen as struggling through 2016 and into 2017. According to its financial report, Miami University Hospital has a current ratio of 0.99, which is suboptimal. Net Patient Revenue is 100,547, which is comparable to JMH. Net Income for Miami University Hospital turned into a net loss of 69.5 million dollars for 2016, largely due to a loss of investments for the following year (“The University of Miami,” 2016).
Key Financial Drivers behind Healthcare Organization Mergers
While there are many financial drivers behind healthcare mergers, the primary motive remains the same – a merger occurs when both organizations perceive the merger as a more financially suitable prospect as compared to being alone. However, this aspect of merging in healthcare organizations has been steadily losing power, as hospitals change from revenue generation towards innovation, effectiveness, and expenses reduction (Harris & Johnson, 2016). Research and development take up a good portion of hospital expenditures. In addition, the reduction of expenses is associated with the ability to control the costs for healthcare services and reduce the burden on available resources.
Healthcare organizations go to great lengths in order to keep themselves up with many technological advancements and innovations that take place. This results in a growing need for financing and investments, as high-tech medical equipment is expensive, and the course for the digitalization of healthcare has also put a toll on hospital budgets. As a result, smaller hospitals have trouble keeping up and competing with larger ones (Harris & Johnson, 2016). Maintaining high standards of care is also problematic, which is why many hospitals opted for merging in the past several years. Hospitals can raise money through several means – either through equity or through getting in debt. Equity is not considered to be the optimal choice, as the costs for the organization end up being higher. One of the best alternatives to raising finances through equity is through bank loans. Merged companies have lower interest rates when compared to unmerged ones, which makes merging even more attractive to healthcare organizations.
Post-Merger Evaluation Criteria
Should Jackson Memorial Hospital and Miami University Hospital decide to merge, it would likely be a decision made to attract additional investments and expand the merged organization’s portfolio of services in order to maintain a competitive edge and serve the patients to the best of the new organization’s ability. When looking at the newfound merger, financial analysts have several parameters to assess before making a decision on whether the merger was successful or not.
The first and most important parameter is the stock price. It represents how well the shareholders and the investors embraced the merger (Bena & Li, 2014). Should the majority of the hospital’s shareholders and investors be happy with the new merger and see it as a beneficial outcome, the price of post-merger shares would go up. However, should the merger organization tumble and show a lack of confidence, the investors might conclude that the company made the wrong choice. As a result, the shares of the hospital would fall, and the investments would decline.
Another important factor to analyze is how well the post-merger organization manages its economy of scale. As the organization’s capabilities after the merger would grow, its prices for services would inevitably go down, meaning a potential influx of new patients. If the hospital manages to capitalize on that advantage, it would benefit greatly and increase its profits (Bena & Li, 2014). Failure, however, is associated with a profit loss followed by a potential decline in combined market share.
The speed of the integration process is an important factor to be considered during analysis. This parameter reflects on how quickly the new merger adapts to change and integrates its systems between the two or more mergers. Rapid integration rates mean confidence and a solid platform upon which the two hospitals build upon. Slow rates of integration, on the other hand, are considered to be the signs of uncertainty and weakness, meaning that investors will look at the merger with skepticism (Bena & Li, 2014).
Lastly, an evaluation can be conducted by calculating EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) (Bena & Li, 2014). It is one of the key metrics in Merger and Acquisition assessment. By using EBITDA, the analyst can discard taxes, interest, and expenses of the merger, as well as negate the effects of capital investment into the organization. The only value left will represent profit after the merger, which could then be presented to banks as proof of success, which would grant access to better loans.
Forecast for the Healthcare Industry in the USA for the Next Three Years
The healthcare industry has a somewhat unique standing in the USA. It continues to enjoy intense growth rates, even when all other industries, and the world economy in general, is plummeting. During the world economic crisis of 2009, the healthcare industry in the USA grew by 6 percent. The growth in the healthcare industry is largely associated with geriatric and palliative care for the aging populace. According to statistics, elderly patients make up 34% of all hospital-related spending, while only accounting for 13% of the general population (Beard, 2015). However, the number of elderly patients is expected to grow. As it stands, the current number of elderly persons in the USA is estimated at around 45 million, and this figure is expected to double by 2030 (Beard, 2015). It means that the number of patients within the US healthcare sector is not expected to go down anytime soon. With the economic situation in the world slowly stabilizing after 2009, and the US economy still showing respectable growth, it can be expected that the country’s hospital industry will grow as well. The introduction of the ACA in 2010 managed to slow down growth rates by imposing additional expectations and demands on the hospital system (Santili & Vogenberg, 2015).
This forces smaller hospitals to merge with larger ones in order to be able to keep up with the new legislations and demands. With ACA being opposed by the current government, it is likely that the burden of various ACA regulations and bureaucratic procedures would be removed. In addition, the growth of patient awareness and the introduction of alternative payment models would enable many Americans who previously avoided healthcare to commit to the market, thus bringing additional customers additional value. At the same time, the competition is expected to increase as new drugs and treatment methods become available. The changes in the pharmaceutical industry from expensive and exclusive drugs towards cheaper and more affordable ones has the potential of opening the healthcare market to low-income and middle-income families, thus contributing to further healthcare market growth (Santili & Vogenberg, 2015). The only potential events that could diminish the potential of the healthcare industry in the USA are political upheaval and an unexpected economic downturn. Nevertheless, while the need for smartphones and gadgets comes and goes, the need for quality healthcare remains constant even in the face of various crises, which promises a prosperous future for JMC, Miami University Hospital, and the hundreds of other healthcare facilities across America.
References
Beard, J. R. (2015). Towards a comprehensive public health response to population ageing. The Lancet, 385(9968), 658-661.
Bena, J., & Li, K. (2014). Corporate innovations and mergers and acquisitions. The Journal of Finance, 69(5), 1923-1960.
Harris, J. M., & Johnson, M. (2016). Is merging a requirement for success at population health management? Healthcare Financial Management, 2016, 120.
Public health trust Jackson Health System combined statements. (2014). Web.
Santilli, J., & Vogenberg, R. F. (2015). Key strategic trends that impact healthcare decision-making and stakeholder roles in the new marketplace. American Health and Drug Benefits, 8(1), 15-20.
University of Miami financial statements. (2016). Web.