Life and Debt at a Private Equity Hospital

In a building next door, the lights didn’t go out, but it wasn’t safe to rely on the backup generator alone. Severely ill patients without Covid-19 needed to be moved from a temporary “clean” intensive-care unit into the main ICU, which had no power issues but was packed with Covid cases. So nurses created a makeshift boundary, a privacy curtain on wheels, to keep the two sets of patients apart. “I was beside myself,” says Jackie Fabre, an ICU nurse. “That was unacceptable. That was terrible.”

The for-profit company that owns St. Elizabeth’s, Steward Health Care, says backup power kicked in after the transformer blew, the outage didn’t affect patient outcomes, and the hospital had been planning to consolidate the two ICUs. Steward also points to the more than $100 million it’s spent to upgrade St. Elizabeth’s. To be fair, the power crisis that began on May 10, and lasted 38 hours, was a confluence of freak events. Medical centers across the Northeast were battling a pandemic. Then a mouse showed up in the wrong place at the wrong time.

But for some who work at St. Elizabeth’s, the outage capped years of complaints about what they see as the company’s penny-pinching approach. Steward has long been heralded as a bold experiment in using Wall Street financial engineering to save community hospitals. A decade ago, Cerberus Capital Management, a private equity firm, bought St. Elizabeth’s and five other Catholic hospitals in Massachusetts. The buyout created Steward, which has become one of the largest U.S. chains of for-profit hospitals, with $6.6 billion in annual revenue in 2018.

The Massachusetts hospitals were hardly a prize. When Cerberus bought them, they were in precarious financial condition and had substantial pension obligations. Cerberus’s ownership wasn’t only supposed to spruce up old buildings but also revolutionize health care. Steward would build an “accountable care organization” under Obamacare, which passed the same year as the buyout and brought the sense that big reforms were possible. Steward’s network of family physicians, specialists, and hospitals could work together seamlessly to manage every aspect of a patient’s health, offering better care at a lower cost to the working-class communities many of the hospitals served.

As the U.S. faces an uncertain economic future linked to the relentless coronavirus, providing affordable health care has never been more urgent. Steward says it’s taken steps toward that goal. It points to improvements in mortality and other measures at its hospitals since the Cerberus purchase. Yet for all of Steward’s impressive growth, the company, like so many created through buyouts, remains on a financial knife’s-edge. To pay off Cerberus and its investors as well as to finance the health system’s growth, Steward has sold off some of its most valuable assets—the real estate its hospitals occupy—and is now saddled with debt.

In May, as St. Elizabeth’s was dealing with its electrical glitch and the crush of Covid patients, it faced another upheaval. Cerberus transferred control of the company to a group of the hospitals’ doctors. In an example of the strange magic of private equity, Steward’s financial struggles now hardly matter to Cerberus. The investment firm has already made its money back several times over.

Private equity firms see health care as a growth opportunity, in part because of the graying of America, and they’ve been buying like crazy. As a whole, they made a record $78.9 billion worth of medical investments last year, according to consultant Bain & Co. Along with hospitals, investors have bought doctors’ offices, surgery centers, and drug-treatment clinics.

Cerberus and the Massachusetts hospitals, which were part of a nonprofit group called Caritas Christi Health Care at the time of the deal, made for especially sharp contrasts. The hospitals were anchors of local communities and had names such as Good Samaritan and Holy Family. Cerberus, named after the three-headed dog that guards the gates of the underworld, is as powerful and connected as they come. Its leadership includes billionaire Stephen Feinberg, former Vice President Dan Quayle, and former Treasury Secretary John Snow.

Private equity typically buys a company, overhauls its operations, and tries to make it grow. Generally this strategy involves piling on a lot of debt—but, crucially, that debt sits on the books of the target company, not the private equity fund. David Johnson, chief executive officer of 4sight Health, a health-care advisory firm, says Cerberus and other private equity firms bring market discipline to an industry that really needs it. “I look at private equity the same way I look at nuclear energy,” says Johnson, who wrote a case study about Steward with one of its investment bankers from Cain Brothers. “It has beneficial and detrimental uses. It is a heat-seeking missile for profits.”

Cerberus needed approval from the state and even the Vatican to do the deal. The firm paid $246 million in cash and agreed that Steward would assume a more than $200 million pension shortfall and make $400 million in investments over several years.

Under its CEO, Ralph de la Torre, a heart surgeon who’d also headed Caritas Christi, Steward lived up to its deal, the state says. It ultimately invested $800 million in its Massachusetts hospitals, with new operating rooms and emergency departments to show for it. Steward recruited respected doctors from rivals, such as Frank Pomposelli Jr., chief of surgery at St. Elizabeth’s. “The care you get here is as good, if not better, than at any Boston hospital,” says Pomposelli, recruited from Boston’s Harvard-affiliated Beth Israel Deaconess Medical Center in 2011.

But almost as soon as the state monitoring period ended, Cerberus did what many private equity skeptics feared. In 2016, Steward sold off some of the hospitals’ property for $1.25 billion. The hospitals now had to pay rent to use buildings they once owned. That helped Cerberus extract a giant gain; one of its funds collected a $484 million dividend, according to a confidential investor document. Mostly because of the real estate transaction, the fund tripled its money. The deal also enabled an acquisition spree. Steward now owns 34 hospitals in nine states, including Florida, Ohio, Pennsylvania, and Texas, as well as two in, of all places, Malta.

Steward ended up with $1.3 billion in long-term debt in 2018. On top of that, it owed more than $3 billion in future lease payments. In keeping with the private equity model, Cerberus didn’t owe that. Steward did. The hospital company is bleeding—a combined half a billion dollars in losses in 2017 and 2018 alone, according its last publicly available financial statements. Based on 2018, the Massachusetts agency monitoring hospital finance rated Steward’s solvency lower than that of any other hospital system in the state.

A spokesman for Steward says it has plenty of cash to meet its obligations, and its underlying businesses are sound and growing. Still, current and former employees complain about chronic maintenance problems and supply shortages, and some vendors have cut off business with Steward. Since early 2019, several companies have taken Steward to court over past-due invoices: two advertising firms, Rev77 in Arizona and Richards Group in Texas, for billings that topped $2 million; Angelica, for $317,000 in hospital linens; Great Eastern Energy, a New York utility, for $250,000 in natural gas bills; and Ohio vendors for $213,000 in flooring and $36,000 for boiler repair. Not long ago, Cape Cod Cafe stopped delivering pizzas for the cafeteria at Steward’s Good Samaritan Medical Center, in Brockton, Mass. Cafe co-owner Jonathan Jamoulis says Steward would pay only after thousands of dollars in bills piled up for six months. “It was a lot of money for us,” he says.

Late payments weren’t just an oversight, according to several former finance employees. Steward instructed staff to delay payments. Mike Green, who worked briefly as a controller for three of Steward’s Ohio hospitals in 2018, says the company wanted to improve its short-term cash flow. “Vendors that were used to receiving a payment in 30 days were waiting 90 and sometimes more than that,” says Green, now chief financial officer at Jaro Transportation Services Inc., an Ohio trucking company. “It snowballed to where we were struggling to get supplies in a timely manner.”

Steward says disputes with vendors have been resolved and reflect a negligible part of its spending. The delays, it says, reflect the difficulty of integrating payments systems in the companies it bought. “We continue to work diligently on this transformation,” the company said in a statement.

Steward and its financial backer pride themselves on being shrewd hospital operators. Under Cerberus, Steward adopted software that it says can predict hospital occupancy with 95% accuracy. That way, rather than focusing on a hospital’s average patient count—and risk being overstaffed or understaffed—Steward can get closer to the ideal. When, as is inevitable, hospitals have more than the expected number of patients, they rely on overtime and contract nurses. Several years ago, the software helped alert one hospital to a coming surge related to a bad flu outbreak. The approach has saved tens of millions of dollars a year, says Mark Girard, a Steward executive and radiologist in Massachusetts. In an investor update, Cerberus said Steward’s “proprietary proactive labor management IT tool” enabled it to reduce staffing by 532 employees in 2013.

But more than two dozen current and former employees say the hospitals are often short-staffed. In their view, the situation can threaten patients, such as those who need supervision to prevent falls. In the business, certain mishaps are considered unacceptable, or “never events.” In 2018, the latest year available, Steward reported 754 falls to the Massachusetts Health & Hospital Association, including 156 with injuries. In many of its units, it had a higher rate of falls than at similar sized hospitals.

The Centers for Medicare and Medicaid Services (CMS) criticized Steward’s response to an elderly patient’s February fall at its Holy Family Hospital in Haverhill, saying it had failed to take steps to “prevent a like event from occurring in the future.” According to a federal inspection report, the emergency room had ordered a one-to-one aide, or sitter, but the patient didn’t have one. The hospital blamed a nurse for turning off a bed alarm; the nurse said she had been overwhelmed with other patients. The company says it has increased sitters at Holy Family and elsewhere in recent years.

Two other indicators suggest inadequate staffing. Leapfrog Group, a quality rating service, says Steward hospitals such as St. Elizabeth’s, Holy Family, and Good Samaritan have above-average rates of some hospital-acquired infections. In Medicare and Medicaid surveys, a lower percentage of patients at those hospitals report that they always got help as soon as they wanted. Overall, the CMS gives low to middling quality ratings to Steward’s hospitals, in part because they have more patients who have to be readmitted after discharge.

Steward says its mortality rate is better than expected based on the underlying health of the patients it treats and that it’s improved since the takeover. The company also cites data showing that since 2016 its hospitals have improved their patient safety index, which measures how well hospitals avoid a collection of 10 serious complications. Steward notes that its hospitals have won awards from Leapfrog and Healthgrades, another rating company, for services such as cardiac care.

An analysis of 2019 Massachusetts hospital association data shows patients in most Steward adult care units on average receive less time in direct care from nurses and aides compared with those in similar-sized hospitals. In Good Samaritan’s ICU, patients received roughly four fewer hours a day of care. Steward says industry data can’t be used fairly to compare hospitals on staffing, because institutions may not be reporting consistently, making it “skewed against Steward.” Patricia Noga, the association’s vice president of clinical affairs, says her group trains hospital officials on what to include and asks them to attest to the data’s accuracy.

Through their union, nurses filed hundreds of unsafe staffing reports with Steward in 2019 and so far in 2020. Massachusetts Nurses Association documents tend to claim that shifts are down a nurse, or that nurses lack assistants, including aides for patients at risk of falling. “Patients had to wait excessive time for interventions including meds, toileting,” one Good Samaritan nurse wrote last September. Patients were “in hallways without monitoring as beds were full.”

At times, nurses say, they’re forced into overtime even after 12-hour shifts, leaving them exhausted. Often, they say, the patients are so sick that they need more than minimum levels of staffing. “Frequently, I’m not performing the job up to standard,” says Stephanie Hinsvark, a St. Elizabeth’s nurse. “I feel like I’m failing my patients.”

Struggling with overwhelming numbers of Covid-19 patients at the peak of the pandemic in the spring, nurses say short-staffing, especially a lack of aides, increased their exposure to the virus. Lisa Mancuso, a nurse at St. Elizabeth’s for 37 years, contracted Covid-19 in May. Although she recovered, she quit her job in June. Mancuso says the church prized patient care, while Steward focuses on profit. “They’re pretty much all about the money,’’ she says. “They made that clear over and over again over the last 10 years. Their M.O. is take care of corporate first. Then, take care of everything else—second, third, and fourth.”

Joseph Weinstein, Steward’s chief medical officer, says the company is working to lower readmission rates through better follow-up with patients. “We do not cut corners on staffing,” Weinstein says. “I will be emphatic on that one.” Steward says the unsafe-staffing reports are a union strategy to gain leverage, rather than indications of serious shortcomings. The complaints can reflect unusually busy nights, a spokesman says, adding that during the Covid crisis, the company flew in out-of-town nurses to handle the surge in virus cases. Steward says it has support for its efforts from other labor groups. Tim Foley, executive vice president of 1199SEIU United Healthcare Workers East, which represents Massachusetts nursing assistants, housekeepers, and others, credits the company for cooperating with workers and keeping struggling hospitals afloat.

Covid-19 has exposed the weaknesses of the entire U.S. hospital industry. Medical centers rely on profitable elective surgery to offset the losses they take on many lines of business, including treating poor patients. In May the American Hospital Association estimated that hospitals and health systems lost $203 billion from March through June, because of the costs associated with treating patients with the virus combined with the inability to treat others.

Steward was no exception, but its finances had deteriorated long before the crisis. Cerberus indicated as much to investors last year. In a yearend update, the investment firm described Steward’s liquidity, or ability to raise cash easily to meet obligations, as “on watch.” Previously, Cerberus had “no concerns.” (In a statement, Cerberus said that “at no time was the Steward investment viewed as at risk.”) More recently, the firm told investors the Covid crisis could cost Steward $500 million.

The company got help from U.S. taxpayers to get through the pandemic. It received at least $400 million in loans from a federal health program and secured a $105 million U.S. grant. Then in May, to stabilize its finances, Steward agreed to sell an additional $400 million worth of property, according to a confidential letter to investors. At the same time, Cerberus made a move to protect its remaining investment. In June, Steward announced the outline of a deal: The private equity firm transferred a controlling interest to a management team of Steward doctors. Cerberus said it was ceding control on “a high note,” calling its investment “a success story.”

Cerberus hasn’t cut all ties. It exchanged its stock in Steward for a kind of bond. Steward now owes Cerberus $350 million through a note due in five years. Cerberus says the note puts its investors in a more “secure place in the capital structure.” In essence, Cerberus is hedging. If Steward were to head to bankruptcy, it will be better to be a bondholder than a stockholder—equity is frequently wiped out. Cerberus says the transaction ensures that Steward has “unfettered access to capital” in the Covid crisis and wasn’t motivated by concerns about bankruptcy.

If Steward trudges on, Cerberus will collect another $350 million when Steward repays the note, plus interest. And if Steward stabilizes its finances and even thrives? Cerberus can convert the note into a 37.5% equity stake. So, whether or not Steward’s nurses, doctors, and patients prosper, or its vendors get paid, Cerberus may yet have another big payday.

©2020 Bloomberg L.P.