Private Equity and Nonprofit Hospitals

March 29, 2010

You knew it wouldn’t take long for the Gordon Gekkos of the world to figure out how to make some new big money out of healthcare reform. The Wall Street Journal’s “Deal Journal” (on deals and deal-makers) may have spotted one new avenue: the purchase of nonprofit hospitals by for-profit private equity investment firms. And that may spell a radical change for the concept of nonprofit hospitals.
Last week the Boston Globe reported that Cerberus Capital Management has consummated a deal to acquire Caritas Christi Health Care, a six-hospital nonprofit Catholic hospital chain that constitutes the second-largest hospital system in Massachusetts. Cerberus is known to the public for its purchases of an 80 percent stake in Chrysler in 2007 and a 51 percent stake in the financing arm of General Motors (GMAC) in 2006. Former VP Dan Quayle is a high-profile Cerberus spokesman and runs one of the firm’s international units. Just recently Vanguard Health Systems, owned by the Blackstone private equity company, purchased the seven hospitals in the nonprofit Detroit Medical Center chain. Blackstone received some attention in 2008 when its cofounder, Steve Schwarzman, was ranked by the Corporate Library as the nation’s highest paid corporate executive with cash salary, bonus, stock options, and restricted shares totalling $702.4 million.
The issue posed by the Journal’s Health Blog Question of the Day” last Friday was, “Will we see more action by investors in the hospital sector?” With the prospect of millions of people shifting from charity care to some form of insurance coverage, the troubled economics of some nonprofit hospitals could shift as well. Hospitals like Detroit Medical and Caritas might have been among the nonprofit hospitals most willing to accept low Medicaid reimbursement levels or let uninsured patients off when they couldn’t pay. But that left them financially troubled.
Even as healthcare reform leaves millions underinsured or uninsured, the economics of nonprofit hospitals will change. While allowing that nonprofit hospitals will still face financial challenges, the Fitch Ratings firm suggests that nonprofit hospitals will benefit from increases in patient volume and “dramatic reductions” in uncompensated care, helped by provisions in the legislation that will promote "efficiency and effectiveness in the delivery of care, with pilot programs and payment incentives." According to several reports, Detroit Medical was already making, not losing, money—and so was hardly in the position of the automaker acquired by Cerberus.
Moody’s “Annual Sector Outlook for Not-For-Profit Healthcare for 2010” predicted increasing merger and acquisition activity in the nonprofit hospital sector, calling it a long term positive trend. Why? For many nonprofit hospitals, the previously uninsured for the most part will be insured, either because they are required to purchase it or because they couldn’t have gotten it prior to the legislation due to preexisting conditions.
As national healthcare reform potentially rectifies much of the charity-care problem, nonprofit hospitals are now in play as takeover targets, even if the private equity takeover groups like Cerberus have absolutely no experience in hospitals. Lots of players have to sign off on the Caritas/Cerberus deal, including the Massachusetts Attorney General, the Massachusetts Supreme Court, and the Archbishop of Boston. Even Vanguard, which is acquiring the Detroit hospitals, owns only 15 hospitals, in Arizona, Illinois, Massachusetts, and Texas.
But some nonprofit hospitals have physical plant needs (upgrades, renovations, expansions), outstanding bond debts, and pension challenges, all of which require large amounts of capital, which may be most readily available from private equity firms like Blackstone and Cerberus.
However, some of these private equity takeover firms are themselves highly leveraged. Blackstone’s Vanguard Health had $1.8 billion in outstanding debt before the acquisition of Detroit Medical. These firms are speculators, and they're willing to borrow to make a purchase, alter their acquisitions (sometimes radically), and then move on.
Unlike the Journal’s, our question is, In the wake of national health care reform, what is the future of nonprofit hospitals? Indeed, is there a future for nonprofit hospitals? Is the Caritas acquisition and conversion to for-profit status simply the first step toward the elimination of the distinction between nonprofit and for-profit hospitals?
The acquisition of nonprofit hospitals by for-profit firms raises questions about the notion of nonprofit hospitals responding to the needs of local communities and providing safety net services. While many nonprofit hospitals have shown little if any greater propensity to provide charity care than their for-profit counterparts—underscored by the decision of the Illinois Supreme Court to pull the tax exemption of the Catholic–owned Provena Covenant Medical Center—others that remembered their tax status and their mission have struggled. One of the more nationally prominent examples is New York City’s St. Vincent’s Hospital, in danger of going under as a result of a $700 million debt burden.
Vanguard appears attentive to this issue, promising to maintain Detroit Medical’s charity care policies. But Vanguard has a hospital background. What about the Cerberus-type firms that enter many of their acquisitions with little or no inhouse expertise, track record, or even interest in health care per se? Caritas could just as well be Chrysler for all the speculators know.
Under healthcare reform, nonprofit hospitals will have to conduct community needs assessments at least every three years and explain how they plan to meet those needs, adopt and publicize standards about their free- or discounted-care policies for people who can't afford their treatments, and commit not to charge charity-care patients more than they charge insured patients (as many hospitals do). Nonprofit hospitals can still complain about taking Medicaid patients, dependent on shaky state budgets for the nonfederal portions, but something feels different now.
There’s some difficulty in discerning much of a dose of charitable values or concern for health care for the poor in the private equity firms. As Lita Epstein at BloggingBuyouts.com observed of private equity firms, “[they] don't have a good track record for improving the properties they buy. They're better known for buying firms, improving efficiencies (sometimes to the company's detriment), milking them for cash, and then flipping them when they can profit.”
When private equity firms begin to show interest in the nonprofit hospital sector—when Gordon Gekko sees a profit potential in a sector that has long cried the financial blues—you know the game has changed. It may be good for the economics of nonprofit hospitals, but it may not be quite so good for the concept of community-oriented nonprofit hospitals.

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