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.