PE-Owned Hospitals Paid Owners Millions and Got Low Care Ratings

(Bloomberg) -- In the years before coronavirus began stressing America’s health-care system, Leonard Green & Partners LP extracted more than half a billion dollars in debt-funded dividends from its hospital venture, Prospect Medical Holdings Inc.

It’s a common tactic for private equity firms like Leonard Green, and it was proving to be profitable in this case. But with hospitals enduring an unprecedented onslaught, the situation is renewing questions of whether private equity’s playbook conflicts with patient care.

While Prospect says it’s more financially sound than when Leonard Green took over in 2010, its federal care rankings have remained near the bottom of the scale and in some cases slipped.

“Even if you’re really good at this, this is a low-margin business,” with the most successful facilities only making about 3.5% to 4% operating margins, said Kevin Holloran, a senior director at Fitch Ratings. “I do think there is some level of miscalculation involved,” he said, with private-equity investors thinking, “I’ve turned around other industries, I can do it here.”

While Leonard Green officials declined to comment, a representative for Prospect said its efforts have saved failing hospitals from closure and preserved jobs, with tens of millions of dollars invested in improving the quality of care and operations.

Before the pandemic reached the U.S., Prospect said Leonard Green was selling its ownership stake in a transaction that would have been completed around now. Leonard Green and Prospect declined to comment on the status of the sale.

The chain, whose chief executive is Samuel Lee, is experiencing the same pressures as other providers in the face of the Covid-19 pandemic with restrictions on outpatient procedures and elective surgeries.

“As states gradually ease these restrictions, we expect the financial strain on all hospitals will be reduced but not eliminated,” the company said in an emailed statement, adding that its hospitals -- some located in virus hotspots like New Jersey and California -- have sufficient personal protective equipment to help keep patients and staff safe.

Before the coronavirus revealed shortcomings throughout the U.S. health-care system, hospitals were already coping with plenty of trauma, including an uncertain political climate and shifts in patient revenues that have raised concern over the fallout for care. At least 30 hospitals entered bankruptcy last year.

Despite the sector’s difficulties, the Prospect investment has been profitable for Leonard Green’s investors, a person familiar with the matter said in mid-March.

Founded in 1989, the firm has raised more than $40 billion of committed capital, according to its website. While its portfolio is varied, Leonard Green is no stranger to health care, with almost a dozen investments in the sector.

Dividend Deals

Leonard Green bought Prospect for about $363 million including debt in 2010 when it was a five-hospital chain in Los Angeles, where the private equity firm is also based. Prospect snapped up other hospitals and clinics, and now operates 17 facilities in five states, according to the company’s website.

In the process, Prospect borrowed hundreds of millions of dollars to pay dividends to shareholders including Leonard Green. The hospital operator added $100 million to a bond offering to cut a check to Leonard Green and other shareholders in 2012, according to Moody’s Investors Service. Then, in 2018, it carved $457 million out of a $1.12 billion term loan and paid it to shareholders.

By the end of 2018, available cash was so tight that Prospect got a $41 million infusion from Leonard Green and members of its management, according to Moody’s. The ratings firm downgraded Prospect deeper into junk last year at B3, citing “shareholder-friendly policies” and the higher leverage resulting from the $457 million dividend.

Prospect subsequently paid down more than $1 billion of loan debt by selling properties in California, Connecticut and Pennsylvania in 2019, and then leasing them back. But the leases mean the company’s leverage will likely remain high, according a Moody’s statement at the time; it no longer rates Prospect’s debt.

Meanwhile, care quality ratings for seven of the 10 Prospect hospitals evaluated by the Centers for Medicare and Medicaid Services, or CMS, have declined since 2016, according to HMP Metrics, a health-care facility analytics service. CMS ranks facilities from 1 to 5 stars, with 5 being the best.

Care Ratings

Prospect acquired all of its hospitals with a current CMS star rating through transactions during or in years prior to 2016, according to previous statements.

Most Prospect hospitals sit at the bottom rungs of quality assessments, according to the agency’s hospital comparison database. Nine have a two-star rating or below, placing them in the lowest 30% of rated hospitals, according to CMS data. Just one Prospect-owned hospital -- Roger Williams Medical Center in Rhode Island -- earned a three-star rating.

For Eileen O’Grady, coordinator at the Private Equity Stakeholder Project, an advocacy group that scrutinizes private equity investments, and the author of a February report on Prospect, private equity’s demand for outsized returns can put patients at risk and can lead to lower quality of care and less oversight.

“Private equity owners, seeking high returns, may be even more willing to cut costs in crucial ways than even other for-profit health care companies,” she said in an interview.

The Private Equity Stakeholder Project has also studied PE investments in other industries, including retail -- calling these investors “pirate equity.”

Immediate Jeopardy

CMS cited Manchester Hospital in 2018 and Waterbury Hospital in 2019 -- which Prospect bought in 2016 -- for falling out of compliance with Medicare rules and putting patients in “immediate jeopardy,” documents from the agency show. Both hospitals submitted plans of correction and regained compliance within the same year, CMS documents show.

At Manchester, intensive care unit staff said in a form dated Feb. 10, 2018 that staffing levels were “not adequate to safely address patient needs with compromises to patient basic hygiene, timely medication administration, and timely patient assessments as required,” according to CMS documents.

In another incident at the same hospital in January 2018, a catheter was left in a high-risk patient for too long and no specialized doctor was present as she prepared to deliver a stillborn, according to documents from CMS. About two days later she was transferred to a different hospital, where she died. An autopsy said the cause of death was a c-section complicated by septic shock and blood clotting.

Manchester Memorial addressed the problems identified and returned to good standing with the agency, according to CMS documents. “We take patient safety very seriously and we are committed to continuing to work closely with our regulators, our physicians and our staff with the goal of providing the safest care possible to our patients,” Prospect said in an emailed statement, adding that privacy laws prevent it from providing any information about specific patient cases.

Financial Distress

Both Waterbury Hospital and Eastern Connecticut Health Network, which includes Manchester Memorial and Rockville General, were in serious financial distress and close to shutting when Prospect acquired them, the company said in an earlier statement.

“When no other hospital operators were willing to step up, Prospect saved the two hospital systems, preserved thousands of jobs, and secured the systems’ existing pension funds, guaranteeing retirement income for many employees,” Prospect said.

A representative from Waterbury Hospital referred a request for comment to a Prospect representative. ECHN didn’t respond to a request for comment.

Prospect has invested about $56 million in the two systems to improve both their clinical quality and their operating performance, the company said, noting that ECHN, for example, has successfully taken steps to reduce the frequency of certain hospital-acquired infections.

All three hospitals were ranked two stars in July 2016, the year Prospect bought them. Although the assessments have fluctuated since then, two are now two-star facilities and one, Waterbury Hospital, has fallen to one star, according to the CMS website.

Prospect said in a statement the star ratings don’t take into account recent quality initiatives at its hospitals, reflecting data from 2015 to 2018.

Difficult Turnaround

Hospitals require significant and continued investment, said Scott Phillips, managing director of Healthcare Management Partners, an advisory firm that works on health-care turnarounds and owns HMP Metrics.

The private-equity model can work, Phillips said, pointing to the now-public HCA Inc. as a success story because its former owners including KKR & Co. invested in growing areas and could support the chain’s leverage and dividend payments.

For hospital operators, things won’t get easier, said Michael Abrams, managing partner of consulting firm Numerof.

“It’s a very tough business, and all trends are pointing downward,” he said.

©2020 Bloomberg L.P.

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