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Jon Walker, Sioux Falls Argus Leader, Published July 19 2009

Cooperation during flood fed merger for Sanford-MeritCare

SIOUX FALLS, S.D. – A friendship, a flood, a retirement and a swift trip to the altar created a health care giant last week.

The marriage of Sanford Health to MeritCare is born of coincidence and opportunity. The idea hatched this spring in a phone call from Sioux Falls to Fargo. On Thursday, the two chief executive officers an-nounced a merger that will result in a business with 19,000 employees and a pool of cash to help pay for new buildings, training and more sophisticated practice of medicine.

The moment had the feel of 2007 all over again, minus the applause at the Washington Pavilion. Two years ago, T. Denny Sanford promised $400 million to a hospital that soon would bear his name. This time, the billionaire banker was not on stage, but his name was never far from the lips of Kelby Krabbenhoft, the Sanford and soon-to-be Sanford-MeritCare CEO. None of last week’s goings-on would have happened without the banker’s money, Krabbenhoft said.

What will happen, Krabbenhoft said, will be imminent progress on a construction schedule for Sanford-MeritCare and what he hopes is growth in services after the merger is official in January 2010.

Sioux Falls will get a new heart hospital and a midtown dome, Aberdeen a new hospital, and Fargo two new hospitals if plans proceed. Much of that has long been on paper, but the merger lines up $700 million in unrestricted cash from the two parties to lubricate the financing process for construction.

The merger itself is not unusual. Sandy Steever, editor of Health Care M&A Monthly, said 55 to 60 mergers occur every year concerning more than 100 of the nation’s 5,000 hospitals. Mergers were hot in the 1990s and are again today as a matter of economics, especially now with the government pursuing new rules for hospitals under health reform. Size corresponds to ability to function well, he said.

“Most hospitals are put on razor-thin margins. If they’re part of a larger group, they can share risk and purchasing opportunities,” Steever said from Norwalk, Conn.

This merger, though, has been outside the norm from the start. Sanford-MeritCare will have two headquarters 225 miles apart – a main office in Sioux Falls and another in Fargo. Krabbenhoft, 51, who lives in Sioux Falls and owns a home there, said he may buy a second house in Fargo or rent an apartment as he splits his time between the two offices. “I think that will work fine,” he said.

Stranger to him is how the two health systems got to this point.

Krabbenhoft met MeritCare CEO Roger Gilbertson in the early 1990s at a convention in Dallas. Krabbenhoft, who once lived in Fargo, was working in Missouri at the time. After he moved in 1996 to Sioux Falls to become top executive at what then was Sioux Valley Hospital, he saw more of Gilbertson.

They both are graduates of Concordia College. Their hospitals shared a history in culture, proximity and challenges, and they grew to share their people and services.

One such visit included a conversation in Fargo between Gilbertson and Dr. Dan Blue, president of the Sanford Clinic. It’s there the merger idea first came up, Gilbertson said.

Two events this year pushed the idea forward. Gilbertson, 72, announced he planned to retire, and the Red River flood forced an evacuation of MeritCare patients. The two systems cooperated in the flood and began thinking of what might happen if Krabbenhoft took an expanded role as CEO of a merged network.

Board members looked at the possibility as a way to address Gilbertson’s retirement and ended up preparing themselves for health care reform in the process.

“Accountability in health care has become in vogue again in all this reform talk, but the government doesn’t like to deal with

700 million different units,” Krabbenhoft said. “They want to deal with large regional accountable health plans. So the incentives are on the table once again for merger and consolidation.”

So the result of the merger seemed a wise approach to coming reforms even though the genesis of the idea was preparing for Gilbertson’s departure.

“I can’t give anyone credit for this, but the coincidental credit is amazing,” Krabbenhoft said in an interview Friday.

Krabbenhoft pitched the merger in a news conference Friday as a step toward hospitals moving past third-level care – covering such needs as open heart surgery and advanced neonatal care – and hitting a fourth level of subspecialties.

“We have to stretch to get there, and we have to really take risks in terms of personnel, in terms of finances, in terms of facilities that we normally just walk away from and those things are then conducted at the Mayo Clinic or in larger urban centers,” he said.

Fourth-level care would include certain organ transplants, head and neck surgery for cancer and other exotic subspecialty needs that generally require a trip outside the region. Alongside that subspecialty work is another body of work involving blood and tissue, which also is sent elsewhere.

“We believe we can now start to capture those and keep those within our system. And those are huge, both in terms of volume and economics. They’re exotic tests. They’re well reimbursed. It means a lot to our systems.”

The downside of merging can be a loss of touch with local consumers, an industry leader said. “No matter what happens to federal law and the economy, you need to respond to that environment so you keep that covenant with the community,” said Rick Wade, senior vice president with the American Hospital Association in Washington.

Krabbenhoft and Gilbertson tried to soothe fears in Fargo that the merger there would mean a loss of jobs. Some jobs might dry up in economies of scale, but the net effect would be higher employment in both cities, they said.

The new corporation would be governed by a 15-member board that includes Krabbenhoft and seven members from each of the current Sanford and MeritCare boards. A north and a south president each would answer to Krabbenhoft.

The two systems each have logos with crosses and a heart, so a new logo will resemble them both, Krabbenhoft said. All the signs will change on the network’s property to reflect the new name. Two years ago, in switching signs from Sioux Valley to Sanford, that chore cost $1 million.

More brewing?

One thing at a time, Krabbenhoft says when asked whether more mergers are ahead for Sanford Health.

“My own sense is ... take care of business that’s in front of you today,” he said.

That business is merging his Sioux Falls-based system with the MeritCare network of Fargo, where his CEO counterpart, Gilbertson, is soon to retire. Gilbertson says, “The reason this merger works is we abut each other but we don’t overlap.”

Neither rules out additional mergers. Here are Krabbenhoft’s comments from an interview Friday:

Q: Whose idea was it to merge?

Krabbenhoft: We provide them with maternal-fetal physician coverage, and we’re involved with them on a clinical basis. ... After one of the meetings, they came back and said, “You know, Roger Gilbertson’s talking about how out in (the) Dakotas we’ve got to be thinking about the next generation, what’s going to come next in terms of size.” I went, “Really?” They said, “Yeah.” I said, “See where that goes.”

Where did it go?

Frankly, I didn’t think about it that much. And then the flood happened this spring. The governor ordered evacuation at MeritCare, and they had to move patients. ... When somebody gives you their patients for care, that’s a precious thing. After the flood was over, a couple weeks had passed. I just picked up the phone and called Roger. ... He said, “You know, maybe we should talk.”

A plane crashed in 1989 in Sioux City, and Sioux Falls people went there to help, but that didn’t lead to a merger. What’s the difference?

The difference in this is it’s all about Roger – Roger’s transition, Roger’s retirement.

Where will the headquarters be?

Both locations.

Does that work?

I think that will work fine. If it was Cincinnati and L.A., it probably wouldn’t, but we’re talking about three hours and 15 minutes.

One country in the world has two capitals – Bolivia – and I don’t know if that works too well. Why will you have two headquarters?

There are perceptual reasons and practical reasons. These two systems ... are big enough that they both warrant corporate infrastructure above for accountability, for oversight, for direction. And there’s no reason to duplicate that, and so we will just use – what was Henry Kissinger? – shuttle diplomacy. We’ll use that model, and that will work just fine.

What does a merger do to your plan to build a hospital in Aberdeen?

This accelerates our plans in Aberdeen. We’ve agreed to move forward ... with construction one year after we break ground on the heart hospital here, which is the next 60 days. So a year from this fall we’ll break ground up there.

You hope a merger helps raise you to a new level of medical procedures. Is your hope to not hear people saying anymore, “I’m going to the Mayo Clinic for that”?

That would be nice.

Would this have happened without Denny Sanford’s $400 million?

No. The reputation and momentum created by Denny’s gift has allowed us to do things that capture the imagination of people like Roger Gilbertson. ... Second, the balance sheet is enhanced so significantly by Denny’s gift. It creates something for anyone we get into business with. Access to capital, a great bond rating, which lowers our borrowing costs. It assures survival. It creates more identity. These are inescapable realities of Denny’s gift.

You made $21 million in ’09. MeritCare lost $13 million in ’08, then made $2 million in ’09. Are you rescuing MeritCare?

If that was the snapshot in time that everybody froze on, I’d have to concur with you. But there have been years MeritCare far exceeded the business performance of Sanford.

Can you get too big?

Big in health care has been going on since the 1980s. The government’s policy drives behavior in the industry. ... The government wants to deal with large, regional, accountable health plans. So the incentives are on the table for merger and consolidation. ... That’ll continue to happen. ... I don’t know where that stops.

Why the name Sanford-MeritCare?

It starts with a name of a person, and then a description. The person had to come first. If it was Johnson and Anderson we might have a problem. But this is like “Ford: Quality Is Job One.” This is the same way: Sanford-MeritCare.