Cerberus' $800M Hospital Buy -- a Wager on Healthcare Reform

(MoneyWatch)  In acquiring the Boston-based Caritas Christi Health System, Cerberus Capital Management has agreed to invest $830 million in the six-hospital Catholic organization, including the assumption of pension obligations, the repayment of debt, operational funds, and $400 million for capital projects.

The question is whether that will be enough to enable Caritas, the second largest healthcare system in the Boston market, to compete with the leader, Partners Healthcare, which includes Massachusetts General Hospital (MGH) and the Brigham & Women's Hospital.

In 2008, Partners launched a 5-year construction program worth $4 billion, and MGH alone is spending nearly $700 million on capital projects. Partners, which competes with community hospitals across the Boston area, also extracts much higher payments from insurers than its competitors are able to get. This revelation attracted a lot of attention after a state commission said that it was one of the reasons for the state's very high health costs.

Despite the competition from Partners, Caritas Christi has managed to turn itself around in the past couple of years. While it lost more than $20 million in its fiscal 2008 year, it was estimated to have income of $31 million for fiscal 2009. Caritas Christi achieved this feat under the leadership of CEO Ralph De La Torre by cutting costs and boosting revenues. It negotiated better rates with health plans and hired a number of surgeons who perform big-ticket procedures. Of course, they require the latest high-tech equipment -- one big reason Caritas was looking for an investor. In addition, its debt and pension obligations burdened Caritas.

However, it's unclear why a private-equity fund like Cerberus would buy a nonprofit hospital system, which it will convert to a for-profit organization. While investors have been scooping up some failing rural hospitals lately, it's hard to think of another major nonprofit system that has been acquired by an investment firm. Cerberus' obvious motive is to resell Caritas for a profit in a few years. By then, healthcare reform is expected to increase the number of insured patients seeking care, which should raise hospitals' value. Cerberus says that its Caritas purchase is a "long-term investment," but it has only pledged that it will not sell the hospitals or take them public for three years.

On the other hand, De La Torre, who will continue to run Caritas, told the Boston Globe that he has been asked to advise Cerberus on other potential hospital acquisitions. So perhaps Caritas' acquisition is part of a long-range plan, but one that goes beyond the Catholic healthcare system. If so, it will be interesting to see where Cerberus strikes next and whether other private equity firms will follow its lead.

If nothing else, Cerberus' large investment in Caritas is a vote of investor confidence in the future of the hospital market. That confidence has been seen in other healthcare sectors. In fact, despite the recession and the lack of debt financing, mergers and acquisitions activity was quite robust in the industry in 2009, especially in the nursing home field. Acquisitions in the healthcare services sector - including hospitals and physician groups - represented 40 percent of the M&A volume, but only 6 percent of the total market, suggesting that few hospitals were acquired. Perhaps that will change with healthcare reform waiting in the wings.

Image supplied courtesy of Jim McIntosh at Flickr.