I was not skeptical enough

A recent webinar held by Day Pitney LLP made me wonder if my previous post may have understated the skepticism that should be applied to private equity purchases of hospitals.

The session was held on February 9 and was entitled, "Recapitalizing Not-for-Profit Hospitals with For-Profit Equity Capital." It had excellent and lucid presentations by Sandford Steever, Editor of The Health Care M&A Monthly; Wayne Ziemann, Managing Director of Alvarez and Marsal Healthcare Practice Group; and Lori Braender and Bruce Boisture of Day Pitney. The slides are here.

The theme of the day was that health care reform activities over the coming years will require massive capital investments to comply with the new federal law and associated regulations and to create accountable care organizations. This is a problem for not-for-profits, which are are often locked out of capital markets or have difficult access to such markets. In contrast, for-profits have an easier time raising capital.

One panelist then reported, though, that for-profits and not-for-profits have generally earned virtually identical after-tax profit margins. He also noted that equity holders demand a high return, in the range of 25 to 30 percent.

These remarks led to a series of questions from the audience: If for-profits are identical to not-for-profits with regard to after-tax profit margins, how can those puny margins be sufficient to justify investment by equity markets? Or putting it another way, if equity holders are demanding a 25-30% return, how do they earn that return if after-tax margins are the same as not-for-profits. Does this depend on flipping the properties in an IPO or to another private equity firm?

The initial reply was startling, "It is an apparent contradiction occurring in the market today."

Expanding on that, it was noted that private equity entry in this field is different from the for-profit hospital companies that have purchased properties in the past. "Private equity firms envision exiting, and not in the far future. Betting that there will be a buyer at some time in the future is the exit strategy. It is quite a gamble. They are banking a lot of health care reform and consolidation in the industry. Beyond that there is not much that is well defined."

Beyond that, there was a suggestion that the play in the marketplace right now is a "bet on a business plan" -- hoping that access to strategic capital will give these companies a competitive edge in the marketplace and grow market share. It is a bet on a transformation in the health care industry -- different payment models, being a low-cost, efficient provider, and wringing out inefficiency and overtreatment. "It is a heck of a bet to make," noted one panelist.

We were reminded that for-profit investors believe that community-based governing bodies lead to poor business decisions by not-for-profits. (This thought parallels the "stale bologna sandwiches" comment noted in my earlier post.) This belief, though, is interesting in light of a comment by one panelist who noted that not-for-profits have done better than for-profits with regard to building integrated networks of care and coordination of electronic health records.

Finally, though, there were two sobering comments from the panelists. The one: "It is kind of like the gold rush in years past."

The other was worse: "A third possibility beyond an IPO or sale to another investor is that the firm will simply shut down."

It was on this point that I concluded last week: Investors may come and go, but the community depends on its local hospital to provide high quality service. It is the residents of the community who are left holding the bag if the hospital corporation reaches the conclusion that ownership is not financially viable.