Private Equity and Healthcare, a Marriage in Crisis

Is Private Equity Having Its Minsky Moment?” is another excellent article from Matt Stoller’s BIG newsletter, something that anyone who is interested in PE and corporate finance should be reading (I referenced a couple of his newsletters previously).

You’ve probably been hearing about salary cuts, furloughed employees, and big losses in health systems around the country. I myself am currently experiencing a sizable pay cut. You may have even heard about the possible impending bankruptcy of healthcare megacorp, Envision. Envision is now drowning because they grew to massive size by buying companies using tons of debt. Because of that massive leverage, if those businesses do poorly, they can’t meet their debt obligations. To give you an idea of how Envision operates, they have less than $500 million in deployable cash on hand to cover $7.5 billion of debt.

Stoller gives a nice summary of why these highly-leveraged private equity companies (and other companies using the same toolbox) are ripe for failure when credit markets collapse.

Private equity is undergoing what the great theorist Hyman Minsky pointed out is the Ponzi stage of the credit cycle financial systems. This is the final stage before a blow-up. As Minsky observed, a period of placidity starts with firms borrowing money but being able to cover their borrowing with cash flow. Eventually, there’s more risk-taking until there’s a speculative frenzy, and firms can’t cover their debts with cash flow. They keep rolling over loans, and just hope that their assets keep going up in value so that they can sell assets to cover loans if necessary. To give an analogy, in 2006, when people in Las Vegas were flipping homes with no income, assuming that home values always went up, that was the Ponzi stage.

Now, what happens with Ponzi financing is that at some point, nicknamed a “Minsky Moment,” the bubble pops, and there’s mass distress as asset values fall and credit is withdrawn. Selling assets isn’t enough to pay back loans, because asset prices have collapsed and there’s not enough cash flow to service the debt. Mass bankruptcies or bailouts, which are really both a restructuring of capital structures, are the result.

I think you can see where I’m going with this. PE portfolio companies are heavily indebted, and they aren’t generating enough cash to service debts. The steady increase in asset values since 2009 has enabled funds to make tremendous gains because of the use of borrowed money. But now they are exposed to tremendous losses should there be any sort of disruption. And oh has this ever been a disruption. The coronavirus has exposed the entire sector.

Everyone wants to make the easy money in a bull market. It makes finance professionals seem competent in running multiple businesses across multiple industries even though their performance often has more to do with the amount of money in the pot driving valuations up. Rolling up companies in high-growth industries by paying top dollar? Piece of cake. But what do you do when the hard times hit? How can your businesses survive when you’ve saddled them to barely function in the best of times?

The business model of the 1980s has been institutionalized in ways that are hard to conceptualize. Sycamore Partners’ takeover of Staples was a recent legendary leveraged buy-out that shows how PE really works. Sycamore Partners is a private equity firm that specializes in buying retailers. Sycamore bought Staples for roughly $1.6 billion in 2017, immediately had Staples take out $5.4 billion of loans, acquired another company, and then paid itself a $300 million payment and then a $1 billion special dividend. Then, Sycamore had Staples gift its $150 million headquarters in the suburbans of Boston for free, after which Staples signed a $135 million ten year lease with Sycamore to lease back its own building.

Healthcare is different because the biggest cost center of most healthcare practices is personnel. And those providers are also typically the only source of profit. This limits the shenanigans you can pull, limits how you can grow, limits the cost floor, and—because of Medicare and agreements with other insurers—limits your profit ceiling. Taking care of people is not a software company or a tech business that can achieve limitless scale at near-zero marginal cost. And what seemed like an easy positive cash flow business isn’t as simple as selling toner.

Tens of millions of people no longer have income, and even those who do are afraid to go back to their old lifestyles. The Fed can’t ultimately can’t print a functional economy. And at the end of the day, no matter how many games you play with debt loads and capital structures, firms have to have customers, and people can only be customers if they have income.

We’re currently in process of bailing out a lot of companies, and low-interest rates will let some of these folks continue borrowing money trying to bide time until they can raise more capital or potentially grow out of their debt. That may not be feasible for long enough to outlast this downturn, especially if the money spigots shut off.

But the issue with bailouts in situations like these is that in recent history they’ve perpetuated a private-profit public-loss business model where PE firms are rewarded for taking on absurd risk because that risk is really on the shoulders of the American people. And without meaningful regulation, this perpetuates the growth of the industry instead of reining in its excesses. Our historically “strong” economy crumbled within about two weeks of the shutdown. That’s overleverage at work.

The actual underlying businesses within these organizations are often still sound once you remove the onerous debt obligations, leasebacks, and other financial machinations. A tiny silver lining of this horrible scenario may be getting some of the rent-seekers out of polluting healthcare.

Coronavirus: The Hammer and the Dance

Another excellent follow-up from Tomas Pueyo about the need to stop doing half-assed mitigation measures.

On one side, countries can go the mitigation route: create a massive epidemic, overwhelm the healthcare system, drive the death of millions of people, and release new mutations of this virus in the wild.

On the other, countries can fight. They can lock down for a few weeks to buy us time, create an educated action plan, and control this virus until we have a vaccine [ed: or treatment].

Governments around the world today, including some such as the US, the UK or Switzerland have so far chosen the mitigation path.

That means they’re giving up without a fight. They see other countries having successfully fought this, but they say: “We can’t do that!”

We can do better together with decisive action and cohesive government intervention/support.

Humans are a communal species. While we need to be alone, right now, we should act together.

Maxims for Academic Medicine

Highlights from Joseph V. Simone’s “Understanding Academic Medical Centers,” published way back in 1999 (hat tip @RichDuszak):

  • Institutions Don’t Love You Back.

A wise colleague once told me that job security was the ability to move to another job (because of professional independence).

  • Institutions Have Infinite Time Horizons to Attain Goals, But an Individual Has a Relatively Short Productive Period.

There is little incentive for an institution to rapidly cut through the bureaucratic morass. An institution will always outlast a dissenting individual, regardless of the merit of the case.

  • Members of Most Institutional Committees Consist of About 30% Who Will Work at It, Despite Other Pressures, and 20% Who Are Idiots, Status Seekers, or Troublemakers.

Generous.

  • Institutional Incompetents and Troublemakers Are Often Transferred to Another Area, Where They Continue to Be Incompetent or Troublemakers.

They force others to pick up the slack or repair their mistakes, reducing everyone’s efficiency. If this continues for long, those who are consistently unproductive may become the majority because the competent learn that the institution sees no virtue in hard work and collaboration.

  • Leaders Are Often Chosen Primarily for Characteristics That Have Little or No Correlation with a Successful Tenure as Leader.

Examples of such criteria include a long bibliography, scientific eminence, institutional longevity, ready availability, a willingness to not rock the boat, or to accept inadequate resources. Choosing leaders is not a science, but it is surprising how often management skills, interpersonal skills, and experience are undervalued.

See: Academic Medicine & The Peter Principle.

  • In Recruiting, First-Class People Recruit First-Class People; Second-Class People Recruit Third-Class People.

Some hesitate to recruit a person who is smart enough and ambitious enough to compete with them. Others want a position filled at any cost because of “desperate” clinical need or other institutional pressures. If that approach continues for long, the third-class people will eventually dominate in numbers and influence and ultimately chase away any first-rate people that remain.

  • In Academic Institutions, Muck Flows Uphill.

Leaders often try to ignore or deflect the unpleasant mess, but the longer it incubates, the harder it will be to sanitize.

See: the dropped balls nationwide with current COVID-19 pandemic.

  • Personal Attitude and Team Compatibility Is Grossly Underrated in Faculty Recruiting.

A faculty member may be very productive personally but create an atmosphere that reduces the productivity of everyone else.

Annoying people are the black holes of camaraderie and joy.

Coronavirus & Distance

There have been lots of good articles about the novel Coronavirus and the embarrassing state of America’s public health response.

This one from Vox has some excellent charts.

This one on Medium breaks down some of the underlying relationship mechanics of social distancing measures and spread as well as how one estimates the number of hidden (but transmitting) cases in a population (which does require some assumptions).

Here’s what I’m going to cover in this article, with lots of charts, data and models with plenty of sources:
— How many cases of coronavirus will there be in your area?
— What will happen when these cases materialize?
— What should you do?
— When?

When you’re done reading the article, this is what you’ll take away:

The coronavirus is coming to you.
It’s coming at an exponential speed: gradually, and then suddenly.
It’s a matter of days. Maybe a week or two.
When it does, your healthcare system will be overwhelmed.
Your fellow citizens will be treated in the hallways.
Exhausted healthcare workers will break down. Some will die.
They will have to decide which patient gets the oxygen and which one dies.
The only way to prevent this is social distancing today. Not tomorrow. Today.
That means keeping as many people home as possible, starting now.

Important reading.

Fragmentation and the Family

Affluent conservatives often pat themselves on the back for having stable nuclear families. They preach that everybody else should build stable families too. But then they ignore one of the main reasons their own families are stable: They can afford to purchase the support that extended family used to provide—and that the people they preach at, further down the income scale, cannot.

[…]

For those who have the human capital to explore, fall down, and have their fall cushioned, that means great freedom and opportunity—and for those who lack those resources, it tends to mean great confusion, drift, and pain.

From conservative columnist David Brooks’ “The Nuclear Family Was a Mistake” in The Atlantic.

Even in medicine, we are seeing a disturbing trend. While the mean and median student debt are rapidly increasing due to high tuition rates, this is actually partially masked by the increasing percentage of medical students graduating with no debt. This suggests that a greater fraction of students come from means and have family support to cover medical school’s incredible cost. And those without that family support are either not getting in or are looking elsewhere.

It doesn’t stop at admission. These disparities and resource differences play out in specialty selection as well:

Over just a six-year period, the number of debt-free graduates almost doubled. And, overall, more competitive specialties like ophthalmology, ENT, urology, radiology have substantially more debt-free graduates than family medicine. Yet, we know we have a specialization problem in medicine. Free tuition at NYU isn’t going to change this massive headwind. The system needs retooling from far, far earlier.