Wednesday, February 23, 2011

Expand and acquire to prepare for the IPO

Today's story that Cerberus Capital Management has offered to buy the financially troubled Jackson Health System in Florida is consistent with an own-it-flip-it approach to investment in hospitals. Part of the business strategy is to create an organization with a larger revenue stream for when it comes time for the initial public offering in a few years. This simply creates a greater sales multiple when the IPO occurs. As we have seen in other sectors in the economy, this phenomenon is remarkably independent of the actual sustainability of the business as an operating entity in the long run. Capital markets flock to size during an IPO.

This is the same strategy being employed by Vanguard Health Systems in buying the financially troubled Detroit Medical Center. Each deal is likely to be highly leveraged, and as long as the cash flow from Jackson/DMC is positive for a few years, the strategy has the potential to yield an excellent return to the investors in the private equity fund.

By the way, you wonder why the newspaper doesn't check its own recent story on Cerberus to make sure it gets its fact right. Today's story says:

Cerberus . . . spent $895 million to buy the Caritas hospitals, including St. Elizabeth’s Medical Center in Brighton and Carney Hospital in Dorchester. As part of the deal, Cerberus agreed to assume $260 million in pension liabilities for workers and pledged to spend $400 million on new emergency rooms and surgery wards.

The one from two weeks ago, however, reports:

Cerberus paid $495 million for the Caritas system, a sum that funded its pensions and retired most of its outstanding debt. It also committed to pumping another $400 million in capital improvements into the system over the next four years, although de la Torre acknowledges that those funds may come from hospital revenues in coming years, rather than from Cerberus itself.


Anonymous said...

If the flip strategy is fraught with peril, for the new buyers that is, is historical experience not a guide? Knowing what we know (and that is where I need assistance), why would highly leveraged turnarounds be so appealing?

I have followed your past posts on this subject Paul, but need some education--I am a novice in this area.

Barry Carol said...

If Cerberus didn’t buy Caritas Christi, would the hospital group have otherwise closed or significantly downsized in the near term? If it did so, putting aside the issue of job losses for the moment, would the healthcare system in the Boston region be net better off or not? If these hospitals need capital for whatever reason and it’s not available from anywhere else, isn’t private equity capital better than nothing?

Anonymous said...

Barry, I guess one could ask the question that, if Cerberus is planning to or does flip it, it becomes a bubble and fails (usually suddenly) in, say, 7 years - would it have been better to fail prior to purchase? Certainly a lot of $$ would have changed hands by then, to what good end I don't know. Otherwise, I really don't know the answer to my question.

Paul Levy said...


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