× Expand Matt Rourke/AP Images When applied to hospitals, the value-extraction strategy that private equity specializes in can lead to terrible outcomes for patients, medical staff, and communities.

“It’s just so messed up that this is all happening,” Lauren McHugh, a registered nurse for 17 years with Hahnemann University Hospital, said at a July rally protesting its closure. “The city needs this hospital. We have frequent patients that have cried, ‘Where am I going to go?’ They don’t know. No one knows.”

Hahnemann, a 171-year-old institution in Center City Philadelphia that serves primarily low-income patients of color, closed on September 6 in one of the more egregious cases of private equity wealth extraction. In 2018, Paladin Healthcare, an entity owned by private equity baron Joel Freedman, bought Hahnemann as part of a small hospital portfolio. He made no improvements for 18 months, and then closed the facility with the intention of selling the real estate, which is set in a “gateway location” for gentrification.

“This seems to have been [Freedman’s] plan all along, to buy this place, let it fail, and shut it down.” McHugh said. Local politicians in Philadelphia and even presidential candidate Bernie Sanders spoke out, savaging Freedman as an avatar of greed. But the condemnations did nothing to stop the closure. Freedman’s lucrative scheme could become a trend, where private equity firms find hospitals in urban areas attractive to developers and strip the assets.

The Hahnemann tragedy represents a new wrinkle in the concentration of the hospital industry: the emergence of private equity as a driving force. Private equity firms are using borrowed money to assemble medical empires across the country. Not only do consolidated hospitals harm patients with higher prices and worse outcomes, but the shaky financial pictures that result habitually lead to massive cost-cutting and closures of unprofitable facilities, which put entire communities at risk of losing access to medical care. It’s the same value-extraction strategy private equity specializes in, only this time it’s quite literally a matter of life or death.

EVEN BEFORE PRIVATE EQUITY entered the picture, hospital networks experienced the same kind of monopolization that has reached into nearly every nook and cranny of everyday life. By 2016, hospital concentration was high in 90 percent of hospital markets. The typical geographic region had three to five consolidated health systems. In 2017, hospitals announced 115 deals.

Hospital executives argue that merging systems will allow them to better coordinate patient care across doctors and facilities, and create efficiencies that reduce health care costs. These arguments have generally persuaded antitrust regulators. In reality, declines in competition when hospitals merge mean that, even if there is a decline in costs, it won’t translate into lower prices or health insurance premiums. Indeed, there is considerable evidence that mergers enable hospitals to pad profit margins by negotiating higher prices for procedures with insurance companies.

Merger activity in California, for example, led to a surge in supersizing hospital systems between 2004 and 2013. According to Blue Shield data, prices across California hospitals were similar in 2004, approximately $9,200 per patient admission. By 2013, prices in the largest hospital systems had increased 113 percent, compared to 70 percent at all other hospitals, a difference of almost $4,000 per admission. While the evidence is less clear-cut, studies also find worse health outcomes for patients and greater variability in the quality of care when hospitals face less competition.

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Private equity has taken a different path to profiting from the hospital sector. Typically, firms begin by acquiring a small hospital system, referred to as a platform company, in a leveraged buyout. Then they add smaller hospitals in geographically dispersed regions, creating a national, multistate hospital chain. The purchases are all financed with borrowed money, and the private equity firms transfer the debt load onto the hospitals.

Unlike traditionally managed hospitals, whose shareholders are committed to their continued operation, private equity owners plan to exit investments in companies they acquire in three to five years. The short time horizons make it impractical for firms buying hospitals to invest in technology, workers’ skills, and quality improvements, all of which require a longer time frame to pay off. Instead, PE-owned hospital systems focus on growing the system by adding on hospitals.

Dr. Barbara McAneny, former president of the American Medical Association: “We have to decide whether the goal of a healthcare system is to increase profits.”

These acquisitions usually fall below the deal size that triggers review by antitrust regulators, allowing them to go unchallenged. In net, however, PE-owned hospital systems can cobble together significant market power by making a series of smaller deals—what health economist Thomas Wollmann terms “stealth consolidation.” Even if the mergers happen to be larger, the hospitals are rarely in geographic proximity to each other, instead serving distinct patient populations. Antitrust regulators see no reason to oppose them.

The acquisition in 2006 of Hospital Corporation of America, Inc. (HCA), by a consortium of private equity firms led by Bain Capital Partners represented a turning point. HCA was a for-profit hospital system that, at the time it was acquired, included 176 hospitals and 92 outpatient surgery centers with a total of 41,850 beds. The consortium acquired HCA for $21 billion, funding 80 percent of the purchase price (approximately $17 billion) with debt.

During 2010, HCA paid investors a dividend of $4.25 billion, which virtually covered the original private equity investment. The consortium turned HCA public on March 9, 2011, raising another $3.79 billion. In the 2006 buyout, Bain Capital invested about $64 million in HCA. By the time it went public, Bain had received about $750 million—equal to roughly ten times its initial investment.

The financial success of the HCA deal spurred other private equity funds to acquire hospitals, an undertaking facilitated by access to low-cost debt in the mid-2000s. By 2011, private equity owned many of the largest hospitals and hospital chains operating at that time, including Community Health Systems (Forstmann Little), Vanguard Health Systems (Blackstone), LHP Hospital Group (CCMP Capital Advisors), Steward Health Care System (Cerberus Capital Management), Capella Health Care (GTCR Golden Rauner), IASIS Health Care (TPG Capital), RegionalCare Hospital Partners (Warburg Pincus LLC), and Ardent Health Services (Welsh, Carson, Anderson and Stowe).

While hospitals in PE-owned health systems do not compete for the same patients, they nevertheless have the potential to disrupt access to health services in local hospital markets. They struggle with high debt loads, and more important, with owners who help themselves to much-needed financial resources. Dividend recapitalizations (where hospitals sell junk bonds and use the proceeds for dividend payments), monitoring agreements (where hospitals pay the PE firm to monitor them), and asset stripping (where the firm sells off hospital real estate and pockets the proceeds) transfer funds from the hospitals to the PE firm and its investors.

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× Expand Matt Rourke/AP Images In September, a private equity owner closed this busy Center City Philadelphia hospital in order to profit on the sale of its valuable real estate.

PE owners would prefer their portfolio companies avoid bankruptcy, but they typically recover their initial equity investments and make a profit regardless. Therefore they may have less reason to focus on the hospital system’s long-term success. The hospitals themselves must employ cost-cutting measures to meet debt obligations, like reductions in staff, closing departments that provide low-margin services, such as obstetrics and gynecology, and selling resource-starved hospitals.

Ultimately, the overhang of debt and the transfer of financial resources to PE owners can threaten the viability of the hospitals. Most recently, long-term care hospital chain New Life-Care Hospitals, which operates 17 facilities in nine states, filed for bankruptcy protection on May 6, 2019. Owned by a consortium of PE firms led by BlueMountain Capital, the chain had previously shut several of its hospitals.

This situation is especially troubling when a PE firm owns a system of rural hospitals in many states, which may simultaneously face disruption, with cascading effects on patients and providers. Dr. Barbara McAneny, former president of the American Medical Association, sounded the alarm: “We have to decide whether the goal of a healthcare system is to increase profits, because private equity firms are selecting those parts of healthcare where they can see a profit because their goal is to make profit.”

Some case studies amply illustrate these concerns.

IN 1996, PRIVATE EQUITY firm Forstmann Little & Co. acquired Community Health Systems (CHS) for $1.63 billion and took the company private. Forstmann used CHS as a platform, and subsequently added on other health care companies. In keeping with PE practice, Forstmann returned CHS to the public markets in 2000 via an IPO, although it continued to own a majority stake.

At that time, CHS had $1.2 billion in long-term liabilities and a high debt/equity ratio of 161.2 percent. In 2004, Forstmann sold its remaining stake in CHS, and CHS borrowed approximately $260 million to buy about half of the shares. Forstmann still played a role with CHS by financing CHS’s continuing acquisitions of other health care organizations.

Between 2000 and 2017, CHS acquired 66 health care companies. For a time, it was the largest for-profit chain in the U.S. by number of hospitals. While CHS was no longer owned by private equity, it continued to operate using the private equity business model, including the use of leveraged buyouts to add on smaller health care companies and loading CHS with dangerous amounts of debt.

Not all of CHS’s acquisitions were small. In 2007, CHS acquired hospital system Triad for $5.1 billion, plus the assumption of $1.7 billion of debt. This nearly doubled CHS’s hospitals to 130. FTC approval was required, but it does not appear that the agency raised questions about the merger. In 2013, CHS made a bid to take publicly traded Health Management Associates (HMA) private in a leveraged buyout. As a condition of approving the merger, the FTC required that CHS divest just two hospitals and related facilities in Alabama and South Carolina. It should not have been difficult to anticipate that a heavily indebted hospital chain acquiring a large, heavily indebted and struggling rival would introduce unacceptable levels of instability.

By June 2015, about a year after the HMA deal closed, CHS’s total long-term liabilities had increased dramatically to $19.7 billion and its debt/equity ratio had nearly tripled to 401.5 percent. CHS struggled to meet these debt obligations. Its share price, which had risen following the HMA merger to $65 a share in July 2015, fell to $13.96 by February 2016.

Stuck in financial trouble, CHS began divesting facilities to pay down debt and avoid default. In April 2016, CHS spun off 38 small, mostly rural hospitals into Quorum Health Corp., a newly created public company, apparently without FTC oversight. Later that year, it sold eight more hospitals to Steward Health Care System. In 2018, CHS divested 11 hospitals; in the first quarter of 2019, it sold seven more. In 2018, Tennova, a subsidiary of CHS, said it would cut staff and “reconfigure” health services at three Knoxville-area hospitals, reducing patient access to some acute-care services. CHS also closed two of Tennova’s hospitals; and in Missouri, CHS closed a 116-bed hospital, leaving local physicians struggling to fill the health care gap.

The CHS spin-off to Quorum Health Corp. created a monopoly provider across rural America: According to trade publication Modern Healthcare, “in 84% of the markets, the hospital is the sole provider of acute-care hospital services.” Quorum, however, was loaded with roughly $1 billion in debt, which it needed to raise and pay off on its own. The debt was “speculative grade,” meaning Quorum was financing its spin-off from CHS with junk bonds.

In the three years following the spin-off, Quorum sold or shuttered 11 rural hospitals in markets with few to no alternative acute-care facilities. The sales yielded $86.5 million in net proceeds to Quorum, which used nearly all of it to pay down debt, not improve the quality of care. Quorum closed Affinity Medical Center, a 156-bed hospital in Massillon, Ohio, in 2018. In April 2019, Quorum sold Scenic Mountain Medical Center, a 146-bed hospital in Big Spring, Texas, to Steward Health Care System. Nearly one-third of Quorum’s initial slate of hospitals have now been sold off.

Divesting the Quorum hospitals did not return CHS to financial stability, either. In August 2019, its shares traded at just $1.81 and the health care system was still selling off hospitals to stave off default on its debt. The private equity assembly of a hospital empire has led to chronic financial struggles and communities threatened with lack of access to care.

STEWARD HEALTH CARE SYSTEM, owned by private equity firm Cerberus Capital Management, was created in November 2010, when the PE firm acquired the financially troubled Caritas Christi system and assumed its debt and pension liabilities. Caritas Christi, the largest community-based health care system in New England, employed 10,000 workers and served more than half a million patients annually.

Steward quickly added five more hospitals in 2011 and 2012—two of which it acquired from private equity–owned Essent Healthcare, Inc. By 2012, Steward was a $1.8 billion company, with 17,000 employees (making it the third-largest employer in Massachusetts); it cared for 1.2 million patients annually. According to Steward’s CEO, Cerberus planned to refine its approach to making hospitals profitable, expand it to other states, and then sell Steward or exit via an IPO.

Things did not go as planned. Cerberus funded the system’s operating losses and acquisitions by monetizing some of Steward’s assets via sale-leaseback deals for its medical-office buildings, and by loading up the system with junk bonds and other debt. As the Massachusetts attorney general reported, “The solvency position of the system declined as debt increased, while operating losses and pension fund charges eroded equity.”

Steward lost money in its first four years of operation; its $131 million profit in 2015 was due to a $132 million pension settlement. Steward’s financial position since then has been unclear, as the system has refused to submit legally required financial information to the Massachusetts Health Policy Commission. It’s impossible to assess Steward’s financial health, or its claim that it has “turned around” the struggling chain.

Cerberus’s investment was rescued in 2016, when Medical Properties Trust, Inc. (MPT) agreed to buy all of the system’s hospital properties. MPT agreed to pay $1.2 billion for the properties and a further $50 million for a 5 percent equity stake in the health care system. Steward now leases back the properties for its hospitals and other facilities, paying rent to MPT. The deal was especially favorable for Cerberus, paying back the initial investment in Steward and more, although the total amount reaped has not been revealed. The deal will also pay down all of the company’s more than $400 million in debt and provide a payoff for top executives.

Within months of receiving the MPT stake, Steward embarked on an aggressive campaign to expand beyond Massachusetts. It capitalized on CHS’s financial instability, acquiring eight hospitals and 7,000 employees in Ohio, Pennsylvania, and Florida in 2017. It does not appear that the FTC performed a detailed review of these acquisitions, despite the fact that the hospital system’s PE owners no longer had any skin in the game, and the valuable hospital real estate would pass to MPT and not be available as a buffer against bankruptcy.

Later in 2017, Steward announced a $1.9 billion purchase of 18 hospitals in Utah, Arizona, Colorado, Texas, Arkansas, and Louisiana from IASIS Healthcare, owned by private equity firm TPG. IASIS had been created as a health care platform company in 1999 by a different private equity firm, JLL. The hospital system grew through hospital add-ons in widely separated markets. In 2004, TPG acquired a majority stake in IASIS via a leveraged buyout.

IASIS failed to go public twice, likely due to IASIS’s extensive junk bond debt. In 2011, IASIS had sold more than $450 million in junk bonds rated five steps below investment grade, and increased its debt burden from 4.9 to 6.5 times earnings, putting it at high risk of bankruptcy. As much as $230 million of the junk bond sale was paid out to IASIS’s PE owners. This was the third IASIS payout to TPG, enabling the PE firm to recoup the last of its $434 million investment.

The merger of Steward and IASIS was subject to regulatory approval by the FTC, which chose to impose no conditions on either party. When the deal closed, it created a network of 36 hospitals across ten states and made Steward the largest private hospital system in the U.S. in both revenue and number of hospitals. The combined system, with 38,000 employees, was expected to generate almost $8 billion in revenue in its first year of operation.

On the same day that it closed the deal for the 18 IASIS hospitals, Steward sold the real estate of 11 of them to Medical Properties Trust (MPT) for $1.4 billion in a sale-leaseback deal that returned nearly three-quarters (74 percent) of the purchase price of IASIS to Steward’s PE owners, but burdened the hospitals with rent payments. In addition, MPT invested $100 million in Steward.

Cerberus’s investment in Steward has already been repaid, likely with a profit. Only the hospital system’s 38,000 employees and the 36 communities its hospitals serve are at risk, should Steward reduce services or shutter hospitals to manage its burden of junk-grade debt. With its most valuable asset—the real estate—no longer available to stave off bankruptcy, Steward’s high debt burden is a clear and present danger to health markets in ten states.

THE LOW-RISK/HIGH-REWARD nature of the PE business model provides incentives to load excessive amounts of debt on the companies acquired. Debt increases the returns to the PE firm and its investors if there’s a successful resale of the company. But it creates a high-risk situation for the company, its workers, and its customers, raising the risk of default and bankruptcy. Paladin Healthcare’s successful closure of Hahnemann Hospital as a real estate–play adds another potential profit-taking strategy that can severely hurt patients.

Antitrust regulators, who expect consumers to continue to have access to the same or an expanded array of health services following a merger, need to be concerned about the extent of leverage on the hospital systems, and the risk that debt poses to their ability to continue to provide services that patients and communities depend on. Mergers between struggling over-indebted hospital systems should be subject to careful scrutiny.

The “buy and build” strategy of platform companies consistently acquiring smaller rivals is now ubiquitous. This has proven more effective for investors than investing in the original company and allowing it to grow organically. PE investors are impatient and plan to exit their investments in three to five years.

In health care, this has meant acquiring smaller hospitals serving suburbs, towns, and rural areas. It’s been an effective way for the hospital system to consolidate ownership and market power on a national scale without coming under scrutiny by antitrust agencies. But multiple hospitals can be threatened if the parent company experiences financial trouble, and can face curtailed services or shuttered hospitals that leave these communities with few or no alternative sources of health care.

These should be important considerations for antitrust regulators.

David Dayen contributed reporting. Research was partially funded by the Institute for New Economic Thinking (INET).