Yves here. Roy Poses has caught Cerberus executing a well-known private equity looting technique to a flagging hospital investment. It’s called the “op co/prop co” strategy, for “operating company/property company”. We described it in a 2014 post, cribbing from Eileen Appelbaum and Rosemary Batt’s book, Private Equity at Work:
For instance, one way that private equity overlords enrich themselves at the expense of the businesses they acquire is by taking real estate owned by the company, spinning it out into another entity (owned by the PE fund and to be monetized subsequently) and having the former owner make lease payments to its new landlord.
The problem with this approach is usually twofold. First the businesses that chose to own their own real estate did so for good reason. They were typically seasonal businesses, like retailers, or low margin businesses particularly vulnerable to the business cycle, like low-end restaurants. Owning their own property reduced their fixed costs, making them better able to ride out bad times.
To make this picture worse, the PE firms typically “sell” the real estate at an inflated price, which justifies saddling the operating business with high lease payments, making the financial risk to the company even higher. Of course, those potentially unsustainable rents make the real estate company look more valuable to prospective investors than it probably is.
Eileen Applebaum provided examples of how this worked (and regularly left bankruptcies in its wake) in an interview with Andrew Dittmer.
By Roy Poses, MD, Clinical Associate Professor of Medicine at Brown University, and the President of FIRM – the Foundation for Integrity and Responsibility in Medicine. Cross posted from the Health Care Renewal website
This looks like the latest trend in the financialization of and diffusion of accountability for health care organizations. The case involves good ol’ Steward Health Care, which was the subject of quite a few Health Care Renewal posts back in the day.
Background – Caritas Christi Bought by Cerberus Capital Management, Became Steward Health Care
Steward is what used to be Caritas Christi Health Care System, formerly a Catholic, non-profit health care system in Massachusetts. In 2010, Caritas Christi was purchased by Cerberus Capital Management, a private equity, aka leveraged buyout firm, which was known for its not very successful run managing Chrysler (look here) and GMAC (look here). Cerberus also had enlarging holdings in the gun industry, later expanded into the Freedom Group, and in military contracting, specifically including DynCorp which hired armed “security forces” and was involved in multiple scandals in Iraq, all of which might strike some health care professionals as inappropriate (look here and here).
Steward Health Care, as run by Cerberus, was one of the earlier leaders in hiring corporate physicians, whom it pressured to avoid “leakage” of patients to other hospitals and doctors, even if some might question whether the care provided elsewhere might be better for those patients (look here). The multimillion dollar a year CEO of Steward suggested the health care had become a commodity, objectionable to those who thought that health care should be a mission-based calling (look here).
After Steward consolidated, operational misadventures began. In 2013, it closed the pediatric unit at Morton Hospital (look here). In 2014, it closed Quincy Hospital, despite promises that it would expand health care services, and specifically not close that hospital so quickly (look here). Starting in 2014, Steward stonewalled state requests to disclose financial data as required by state regulations after the private equity takeover (look here). In 2016, Steward continued to withhold financial data (look here), and closed the short-lived family medicine residency program at Carney Hospital, amidst complaints by the residents about poor organization, and inadequate numbers of faculty (look here).
Steward to Sell All its Hospitals, but Keep Running Them
This week, the Boston Globe reported a stunning example of financial engineering:
Steward Health Care System said Monday that it lined up $1.25 billion from a real estate investment firm that will help the Boston-based company finance a national expansion, pay off debt, and return money to the private equity firm that bought it almost six years ago.
Steward said Medical Properties Trust Inc. would buy all of its hospital properties for $1.2 billion and pay $50 million for a 5 percent equity stake in the company. Steward will lease the properties from MPT, based in Birmingham, Ala.
Note that nearly all the “financing” was obtained by selling all the hospital properties, which somehow sound like the core assets of a hospital system.
Of course, current Steward management thought it was a great idea:
Steward’s chief executive, Dr. Ralph de la Torre, said the MPT investment will give Steward a second source of capital funding and allow it to grow its model of community-based care in other states. ‘This validates the model,’ he said in an interview.
Presumably he was talking about a financial model, maybe the model used by private equity firms (see below). It did not appear that this model had anything to do with providing health care to patients.
On the other hand, perhaps Dr de la Torre was enthused because he stood a chance of personally profiting from this deal, which
is also designed to allow top Steward leaders to have a ‘substantially larger stake’ in the company.
The implication is that Dr de la Torre would end up with some piece of Steward, Cerberus, and/or MPT.
Furthermore, the deal apparently would let Cerberus Capital Management recover all the money it initially put into its buyout of Caritas Christi:
The entire initial investment to Cerberus will be paid back, but the amount is proprietary, de la Torre said. The deal will also pay down all of the company’s $400 million in debt, he said.
This would apparently now render the initial take-over of Caritas Christi financially risk-free for Cerberus Capital Managment, but perhaps not risk-free for patients and health care professionals (who essentially were not mentioned in the article.)
Summary – What Happens When Private Equity Owns Hospitals
– Private equity is just the new name for leveraged buyout firms (the type of firm described the book, and later movie Barbarians at the Gate.)
– Therefore, when they buy out firms (e.g., the primary care practices discussed above), they use borrowed money.
– But they leverage in two senses. Once firms are bought, the private equity owners makes the firms take out further loans, and the money from them may go back to the owners, usually in the form of a special dividend, to pay down the debt originally incurred by the private equity owners. This leaves the bought out firms heavily in debt, but frees the private equity firm from its original debt. If the firm is eventually sold, the new buyers take over the debt. In a worst case scenario, however, the bought out firm goes bankrupt, the private equity’s firm stock in it becomes worthless, but the private equity firm need not be responsible for its financial obligations.
– If the private equity firm desires more money while it still owns the acquired firm, it may sell parts of it off.
– To make the finances of the acquired firm look more attractive to the next buyer, the private equity firms often undertakes short term cost cutting measures that may involve layoffs, increased workload on remaining workers, etc.
Other dark aspects of private equity are discussed on the Naked Capitalism blog here.
So Steward Health Systems, which bought out by Cerberus Capital Management, has now largely followed this playbook. Cerberus initially infused hundreds of millions into Steward, ne Caritas. Steward then closed facilities and programs, and otherwise cut costs. Now Steward is going to sell off its biggest assets, the actual hospital facilities that one might think are at the core of hospital systems. Doing so apparently would allow Cerberus to at least break even on the deal, while still remaining in control.
But now Steward Health is split. It is still owned by Cerberus. Its major facilities would be owned by Medical Properties Trust Inc. Apparently, Steward would have no assets other than its employees. Of course some employees, that is, top management, would be more equal than others, since they are likely being paid millions in compensation, and would have the opportunity to enlarge their stakes in “the company,” although whether that company is Steward, Cerberus, or even MPT is not clear.
Thus, a hospital system which ostensibly exists to take care of acutely and chronically ill patients, often in their hours of need and vulnerability, would now be split among multiple corporate entities. Who woud actually be in charge of upholding the mission? Who would be accountable when things go wrong? Those questions are not clear.
But it does seem likely that top executives of Steward, Cerberus Capital Management, and perhaps Medical Properties Inc stand to personally gain from this bold bit of financialization. Whether patients may benefit, or health care professionals work and ability to care for patients might be facilitated by all this is not clear, and was not addressed in the current article.
As we have said again and again,…
Physicians need to realize that to fulfill their oaths to put patients first, they have to reduce the influence of rich and powerful organizations with other agendas, like health care corporations, and especially corporations owned by private equity. The metastasis of private equity into the corporate practice of medicine and into hospitals and hospital systems should make us all rethink the notion that direct health care should ever be provided, or that medicine ought to be practiced by for-profit corporations. I submit that we will not be able to have good quality, accessible health care at an affordable price until we restore physicians as independent, ethical health care professionals, and until we restore small, independent, community responsible, non-profit hospitals as the locus for inpatient care.