Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How a Hospital Merger Crushed Patient Prices
Transcript
- Lucas: So in 2024, a study from the University of Chicago and Stanford found something that should make any operator think twice before buying a competitor in the same market. When two hospital chains in the same city merge, patient prices go up by an average of 11 percent. Luna: 11 percent is not a rounding error. That's real money for insurers, employers, and anyone with a deductible. Lucas: Right. And the mechanism isn't some backroom conspiracy. It's just market concentration giving the merged entity leverage to renegotiate rates with insurers. The study looked at 382 hospital mergers over a decade. And the price effect is almost entirely driven by deals that put a large share of the market under one roof. Luna: Let's make this concrete. You mentioned the Ascension–Providence St. Joseph merger in Seattle. Lucas: That deal closed in early 2027 — so just a few months ago. Ascension already owned Swedish Medical Center, one of the biggest systems in the Seattle area. Providence St. Joseph had a network of community hospitals and outpatient centers. Combined, they controlled roughly 80 percent of the private hospital beds in King County. Luna: Eighty percent. That's basically a duopoly with one player having all the cards. Lucas: Exactly. Now, the deal was structured as a nonprofit to nonprofit merger, so it didn't face the same shareholder scrutiny a public company would. But the antitrust questions were obvious. The FTC actually sued to block it in late 2025, arguing it would lead to higher prices and reduced quality. Luna: I remember that. The FTC lost in district court. The judge bought the argument that the merger would create cost savings that would be passed on to patients. Lucas: Which is the standard defense in every hospital merger. And the data from the Chicago–Stanford study suggests it's almost never true. The savings — if they materialize — stay on the hospital's bottom line, and prices go up. So let's talk about the specific contract language that made this price increase almost inevitable. Luna: I want to hear this. Because I assume the earnout structure in this deal is relevant. Lucas: It's central. The merger agreement had an earnout tied to what they called 'revenue synergies.' The target was $300 million in additional revenue by the end of year two. Now, revenue synergies in a horizontal merger — that's a euphemism. It's not like merging two software companies where you can cross-sell. In hospital M&A, revenue synergies come from negotiating higher reimbursement rates from insurers. Luna: So the earnout literally rewarded the merged entity for raising prices. Lucas: That's the uncomfortable truth. The sellers — the Providence St. Joseph board — had a fiduciary duty to maximize the value of the deal. They negotiated an earnout that paid out if the combined system boosted revenue. The easiest way to boost revenue? Renegotiate with insurers. And with 80 percent market share, you have the leverage to do it. Luna: And the insurers basically have to say yes. They can't afford to drop a network that covers four out of five private beds in the city. Lucas: That's exactly what happened. The new system sent out new contracts to the major insurers — Premera, Regence, Aetna — with proposed rate increases of 15 to 20 percent. Some of them pushed back, but in the end, the blended increase landed around 14 percent. The earnout is on track to pay out in full. Luna: So from an operator's standpoint, buying a competitor in a concentrated market is a predictable way to generate revenue growth. But it comes with regulatory risk and reputational risk. Lucas: Absolutely. And the FTC isn't going to stop trying. They're already appealing the Ascension decision. But the lesson for anyone doing M&A is: if your deal model relies on 'revenue synergies' in a consolidating industry, you need to be honest about what that means. It's almost certainly market power, not efficiency. Luna: And the earnout structure needs to be carefully designed. If you tie earnouts to top-line revenue in a merger that reduces competition, you're essentially writing a check for price increases. Lucas: Right. A better approach would tie earnouts to cost savings or quality metrics. But those are harder to measure and harder to achieve. That's why revenue earnouts are so common — they're simple. But simple can be dangerous. Luna: Okay, so let's pivot to what operators should actually look for when they're considering a horizontal acquisition in healthcare or any concentrated market. Lucas: First, do a real market concentration analysis. The Herfindahl-Hirschman Index — the HHI — is the standard metric. If your deal pushes the HHI above 2,500, expect a challenge. In the Seattle case, the HHI went from about 1,800 to over 4,000. Second, scrutinize the earnout. If it's revenue-based, ask: where is that revenue coming from? Third, build in an indemnity escrow for antitrust risk. Luna: The indemnity escrow we talked about in episode 21. But specifically here, you'd want the seller to indemnify the buyer if the deal gets unwound or if regulators impose conditions. Lucas: Exactly. In the Ascension deal, there was no indemnity escrow because it was a nonprofit merger without a traditional buyer-seller dynamic. But in a private equity or strategic acquisition, you'd want at least two to three percent of deal value held in escrow for 18 to 24 months to cover potential antitrust remedies. Luna: And what about the buyer rep letter? How does that play in? Lucas: The buyer rep letter — we covered that in episode 25 — is a representation from the buyer that they have the financial capacity to close. That's less relevant here. But the seller rep letter, where the seller represents that the deal doesn't violate antitrust laws, is critical. In horizontal mergers, that representation is almost impossible to make honestly if you have any market power. So buyers often demand it anyway, and sellers push back. That tension is where the deal can break. Luna: It sounds like the best defense is a good offense: do your homework on market concentration, structure earnouts around efficiency not revenue, and have a robust indemnity mechanism. Lucas: That's the playbook. And I'd add one more thing: be prepared for the FTC to use the Chicago–Stanford study as evidence. It's already been cited in multiple complaints. The data is public, the methodology is solid, and it directly rebuts the cost-savings defense. Luna: So if you're planning a deal that consolidates market share, you need a narrative that goes beyond 'we'll save money.' You need to show how patients and employers will actually benefit. Lucas: Precisely. And that's where most deals fall short. The Ascension–Providence merger's defense was largely about charity care and community investment. But so far, the data shows charity spending as a percentage of revenue actually declined slightly after the merger. Luna: That's a tough sell in front of a judge. Lucas: It really is. Look, I think there are legitimate reasons to merge hospitals — improving care coordination, investing in technology, attracting talent. But those benefits don't automatically follow from consolidation. They have to be built into the deal structure. Luna: Before we wrap, I want to circle back to the earnout point. Because the Ascension case is a cautionary tale, but it's also a learning opportunity for operators who are structuring earnouts right now. Lucas: Absolutely. And on that note — quick honest thing. This show is ad-free, and the only reason we can keep drilling into these M&A mechanics is that a small group of listeners chips in monthly through buy me a coffee dot com slash fexingo. If these conversations have helped you avoid a mistake or structure a better deal, that support is what keeps the episodes coming. Luna: Yeah, it's a straightforward model — no sponsors, no affiliate links. Just listeners who find value in the show and want to keep it independent. And we're grateful for every one of them. Lucas: So back to the earnout. If you're structuring one in a horizontal deal, consider making it a blended metric: a portion tied to cost savings, a portion tied to quality outcomes like readmission rates, and maybe a small piece to revenue — but only if that revenue is clearly linked to new services, not price increases. Luna: That's a much more defensible structure, both legally and ethically. Lucas: And it aligns the incentives with what the deal was supposed to achieve in the first place. That's the whole point. Anyway, this is a live issue. The FTC is going to keep challenging these deals, and operators need to be ready. Luna: Next time, I want to talk about how earnouts are evolving in the tech sector. I've been seeing some creative structures in SaaS acquisitions. Lucas: Good idea. We'll save that for episode 31.