Chester County Hospital looks for bigger partner

No community hospital board easily votes to give up the hospital's independence and tie its fate to a larger health system.

But that is what the boards in control of the 120-year-old Chester County Hospital did this month, after deciding that the $150 million to $275 million needed over the next decade to fulfill their vision for the institution was more than it could get on its own.

"We'll find a partner where there's a cultural fit and get access to capital and grow into our vision," Michael J. Duncan, president and chief executive of the Chester County Hospital & Health System, said last week.

What Duncan and other Chester County Hospital leaders see in the future of the institution, one of the few remaining independent hospitals in the region, is more outpatient centers, an expanded physician network, and heavy investment in information technology to accommodate large-scale changes in health-care delivery.

The West Chester hospital currently has outpatient centers adjacent to its main campus, in Exton, and in Kennett Square. Meanwhile, competitors - including deep-pocketed rivals, such as Jefferson Health System and Christiana Care Health System - are encroaching from all sides, attracted by Chester County's relatively fast population growth and high incomes.

Despite the economic strength of its community, "Chester County Hospital has always operated with a relatively thin margin," said William W. Wylie Jr., chairman of the Chester County Hospital & Health System Board.

"As a small, independent hospital, its leverage with payers is limited. It has been the growth of the county that has really allowed us to grow our presence here. It hasn't been because we've had large operating margins," he said.

Other remaining independents include Doylestown and Grandview Hospitals in Bucks County, as well as Holy Redeemer Health System, whose proposed merger with Abington Health fell apart last month.

Chester County Hospital's less-than-stellar financials could be an even bigger problem in the future, experts said.

"We have found that organizations that don't have an operating margin between 5 and 6 percent, probably even higher now, aren't going to have the profitability they need to make capital investment," said Mary Ann Holt, a partner specializing in operations improvement at IMA Consulting in Chadds Ford.

Chester County Hospital's operating margin was well below that benchmark, averaging 2.72 percent in the three years ended June 30, 2011, according to the Pennsylvania Health Care Cost Containment Council. The hospital has not yet reported results for the fiscal year ended June 30. Along with related entities, it had an operating loss of $1.55 million in the nine months ended March 31.

Chester County Hospital learned firsthand last year how tough the capital markets can be. The hospital planned to borrow $57.4 million in the bond market to build a $45 million patient tower and repay older debt, but found the interest rate demanded by investors - more than 7 percent - too onerous.

Instead of taking on the high-cost 30-year bond debt, the hospital borrowed $37.5 million from Fulton Bank at an interest rate of 3.75 percent for just five years.

Moody's cut Chester County Hospital's bond to junk status in conjunction with the planned bond offering in March and kept it there, switching the outlook from stable to negative in December, when the hospital decided to get a bank loan instead.

Competitors Christiana Care and Jefferson Health System, by contrast, have high investment-grade ratings, low debt loads, and no difficulty raising money.

Christiana Care, based in Newark, Del., is developing a 72,000-square-foot outpatient center on Route 202 just over the border in Pennsylvania. The system already has a cardiology practice in West Grove and considers southern Delaware County and parts of Chester County as part of its market.

Jefferson Health System's Main Line Health has outpatient centers in Newtown Square and Exton. Jefferson's financial muscle is prodigious, enabling the organization to pay for $1.3 billion, or 90 percent, of its capital spending since 2007 from cash flow, as opposed to debt, according to Fitch Ratings.

Even the financially struggling Crozer-Keystone Health System has pushed outpatient services into western Delaware County's Glen Mills area, where it competes with Chester County Hospital.

Given all the activity in the area, "they've got to do something," Holt, the IMA health-care consultant, said of Chester County Hospital. Holt said the organization had low operating costs and was smart to affiliate with Children's Hospital of Philadelphia and the University of Pennsylvania Cancer Network, with the Cleveland Clinic for heart surgery.

At the suggestion of its investment bank, Cain Bros. & Co. L.L.C., Chester County Hospital is casting a wide net for merger partners, including private equity and for-profit buyers.

"As a practical matter, we expect we'll end up with the shorter list of at least roughly proximate hospitals," said Duncan, who became CEO in May 2011, succeeding H.L. Perry Pepper, who retired after 34 years at the hospital.

Kevin Holleran, chairman of the Chester County Hospital Foundation, said the decision to give up the hospital's independence was unanimous.

"Everyone was convinced that this is the right step," Holleran said. "It was an intense discussion, but not contentious."