Cerberus Uses Private Equity Looting Strategy With Scandal-Ridden Steward Health Care Hospitals

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

We have previously described the private equity playbook here, and here.  The main points were:

–  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.

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  1. JohnnyGL

    Thanks for covering this story Yves. My mother had a brief stay in one of the Caritas hospitals several years ago (wasn’t long after Ceberus had taken control and created Steward).

    During her stay, the sink was broken, the toilet was broken, there was no toilet paper and no soap in the soap dispenser. After she got out she swore never to go back again.

    The MA Democratic Party was completely on board with this and I recall Deval Patrick (who’s got a job as Managing Director at Bain, I see. Isn’t that lovely?) raising plenty of money from Cerberus and Martha Coakley as AG oversaw a waive of acquisitions and consolidations among health care providers.

    To add to the filth, I think the only reason that the Catholic Church needed to sell the Caritas chain was to settle lawsuits surrounding sexual predator priests.

    1. Mike G

      Neoliberal MBA culture in a nutshell. If you don’t care about the quality of service, any monkey can “make money” on the phoney-baloney financial statement, for a short while.

      I went through something similar where I used to work. We were an independent Catholic hospital that joined a Catholic hospital chain. They charged massive management fees and demanded all kinds of expensive measures to ‘standardize’ operations, yet never put much investment into the place; we found out why. After the five-year minimum operating requirement was up they shut us down and demolished the buildings to sell the real estate. Not a private equity operation, but the same spirit of running a “bust-out“.

      1. BRUCE E. WOYCH

        Mike G.: …For research purposes, could you please name the hospitals involved and the location as well as the circa date /year (s) involved. NYS is a hotbed of this manipulation starting under Governor Pataki and the false front strategies of the Berger Commission. It sounds very Stately, but Stephen Berger (seehttp://www.nakedcapitalism.com/2016/05/hospital-profits-and-quality-may-fall-but-hospital-executives-compensation-keeps-rising.html#comment-2590446) was always the CEO of Private Equity as he led this “commission” to scuttle NY non-profit public sector hospitals.
        I would appreciate knowing more about your reference of events.

  2. Richard H Caldwell

    It took just 30 short years of applying neoliberal finance and tax theory to destroy our vibrant system of non-profit, often volunteer-assisted hospitals. I think federal condemnation is likely the end strategy, after PE has left a huge crisis in its wake.

    What Poses does not explicitly say is that for-profit and health care do not belong together. The incentives for each inevitably lie in opposition to the goals of the other. Today even private charitable institutions are suspect as health care providers, many having been captured by neoliberal management teams and turned into financialized, de-facto for-profit entities thinly cloaked in non-profit shells.

    As a child, I was all for “free enterprise”. Having watched the relentless rise of amoral financialized predator corporations, I now believe only government can provide the health care we need and deserve. It’s time to lower the eligibilty age for Medicare to zero and to take all aspects of health care, particularly pharmaceuticals and hospitals, back into sincerely-committed non-profit stewardship.

    1. beth

      But beware. Medicare is not like it was when my mother was alive. It was not perfect then but gets worse each year now. It is moving in the direction of ACA in many ways. Frightening.

  3. Teejay

    Am I looking at too small a sample size (confirmation bias) or are PEs just the scum of the earth? Are there any PEs that are a net plus for the real economy are are they all just blood sucking parasites? My town hospital built as a memorial to those who died after WWI will soon be a for profit entity and I fear what will become of it.

    1. JohnnyGL

      You’re right to be afraid. The Caritas chain used to be a non-profit group, owned by the Catholic Church. They had done a good job for many years. Now it’s garbage.

    2. beth

      Personally I think you are right. I watched PE destroy the middle class jobs on an entire city of 250,000 or 300,000 in the ’80s. At the beginning of the ’80s this city had 7 fortune 500 companies headquartered there. All were broken up with some remnants left by 1990. Talking to research engineers whose good/great ideas ignored and dropped was painful. Also, these firms had their over-funded pension funds raided.

  4. toledo

    “Only gov’t can provide the healthcare we need and deserve “..?
    Not with American crony capitalism- medicare “advantage”, managed medicaid, ie, the huge vat of “Govt money” (actually your tax money at work) that insurance and private equity owned hospitals went after with obamacare. Now that bubble is deflating, and you will see the breakup of CHS (already in play), with others like Tenet healthcare (run by Larry Robbins) likely to follow this end-game exit strategy to complete a very profitable endeavor (for the managers).
    As far as who’s gonna take care of the patients……

    1. Felix_47

      As an older physician I have watched as American medicine has dramatically degenerated. Medicare was the first blow. Doctors eagerly jumped on board since they were getting paid for patients they treated for free before. So did hospitals. I noticed the hospital parking lots, once mostly Chevys and Oldsmobiles started filling up with Cadillacs and Mercedes. And soon we started to see more and more unnecessary treatment. This increased doctor demand. The government liberalized doctor immigration thinking it would be cheaper to have doctors from India or some other third world place competing and they wanted the same level of life style as the American doctors and they too began to increase the levels of unnecessary treatment since in their native countries medical care was rationed based on who could pay and when the USG was paying patients got all the care they could stand. Why stay in Pakistan when the USG is handing out money for medical care? More treatment leads to more complicaitons and the need for more doctors and more procedures. And now the big insurance and health care companies are feeding at the USGovt trough. I have seen a lot of pressure exerted by the health care companies on doctors to do unnecessary surgeries and often they recruit doctors who they know will do it. And then our benefits system run by attorneys is based on medical procedures. I have had many attorneys call me and ask me to do a spine fusion with screws so they could convert a $30,000 soft tissue backache to a $500,000 case. Many surgeons will do it. What is the solution now? I think it is too late to return to the past. We need to put all doctors on salary with no productivity bonus. Their only reward will be to treat and see patients do better. With doctors on salary all incentives for overtreatment will vanish. The hospitals will see a drastic drop in income but it was all false anyway. Hospitals should probably become all government run…..they are government supported now without real accountability. Hospital administrators, now earning huge salaries, should become government employees. The notion that much of private medicine is private is a mirage. Virtually all care ends up coming out of the USG. Firemen generally provide mostly medical care….EMT calls…..and no one complains when they do not work and hang around the firehouse on government salary. Why should it be any different with doctors? Nobody burns buildings down to keep firemen busy. We have more than enough doctors to provide effective care in this country. We do not and never will have enough doctors to provide limitless ineffective care in this country even if we import all the doctors from the third world. And many third world countries have medical schools designed simply to produce doctors for the US market since there are so few job opportunities for their citizens.

      1. BRUCE E. WOYCH

        Pardon my cynicism but I might actually question your credentials since you do not post your name or status. Much of what you rant is more low level political economic neoliberal republicanism (wandering talking points) against government not any comprehensive medical nostalgia. The University system and the AMA are more responsible for importing foreign physicians than any particular government divisiveness, and that was to make sure controls were in place for the living standards of American born (and often lineage based) physcians.. As far as the “good old days” I could cite good reasons why we are happily out of that era. The idea that there are enough Doctors to provide effective care is simply not factually accurate. Salaried doctors is not a movement towards a Universal One Payer plan supported by public funding, it is a hospital initiative to create contingency worker conditions under contracts that bind physicians to hospital dependent survival and subordination; which essentially means making them subject to CEOs and inevitably flag ship ownership by private equity.

        1. Procopius

          I don’t want to defend him, since you are exactly right, but I think you may have misread one sentence he wrote: “We do not and never will have enough doctors to provide limitless ineffective care …” You stated it correctly. that there are sufficient doctors to provide effective care. The idea that this country cannot provide sufficient medical care for all its citizens is disgusting.

  5. diptherio

    I think the fact that these…er…less-than-stellar individuals chose to name their firm after the three-headed dog that guards the gates to Hades should tell us something. It almost makes me want to start up a finance firm called Malebolg & Beelzebub Wealth Management, just to see how many people would bite.

    1. Octopii

      Wonderful :-)

      Always makes me think of Gene Wolfe’s stunning and weird masterpiece “The Fifth Head of Cerberus.”

  6. Nelson lowhim

    I’ll ask it: how exactly do docs in a hospital system go about challenging that drop in patient care?

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