Monday, October 29, 2012

Capital flows to private equity

An MD friend and colleague is intrigued by the financial machinations beyond private equity investment in hospitals.  At heart, I think he agrees with this columnist on Kevin, MD, who wonders whether there is a place for this kind of investment.  But in the meantime, he mulls this quote from a New York Times story about the growing popularity of junk bonds:

Then there are the bonds issued to pay dividends to a company’s private equity owners. The hospital company HCA borrowed $2.5 billion on Oct. 16, in part to make payments to its three private equity owners — Kohlberg Kravis Roberts, Bain Capital and Merrill Lynch Global Private Equity. Mr. Penniman said that deals like this, in isolation, increase a company’s debt and make it harder to fulfill its obligations to bondholders. A spokesman for HCA, Ed Fishbough, said: “We’re pleased with the response to our offering” from investors, and also with the company’s debt levels. 

I explain that this growing popularity is a reaction to the low-yield environment in the marketplace, where there is a tremendous amount of cash looking for a home.

He replies:

As I am learning about private equity, I am puzzled by what passes as "normal."  I am not saying ethical.  Does HCA sell bonds to pay its private equity owners because they have to, or is there something else going on that story does not discuss?

I answer:

They have capital commitments to their owners.  It is part of the deal, extracting $ along the way for the PE investors.  Of course, it is by no means arm's length.  So it is just a way of giving the investors an early reward for taking the "risk."  But, in truth, it is a low risk because the cash extraction is part of the pro forma in the first place.

It is all legal?  Yes.  Is it normal? Yes.  Is it all ethical?  As they define the word, yes.

1 comment:

Anonymous said...

One wonders if PE in health care is not a giant game of musical chairs, to see who is left holding the 'asset' when all the money goes out of health care.