Friday, July 22, 2011
In earlier posts I have discussed the “care/profit tradeoff in nursing homes,” focusing on the role of private equity firms in reducing costs by limiting the liability of their enterprises. Cutting nursing staff and increasing the risk of elder neglect isn’t so costly for private equity barons when “complex corporate structures . . . obscure who controls their nursing homes.” One firm constructed a particularly notable series of corporate moats between itself and the nursing home which it first controlled, and then rented land to.
Daniel JH Greenwood has called a good deal of private equity activity a form of looting, and I have explored its shortcomings in a review of a book on the topic. Sadly, it appears that the private equity influence in Britain is undermining a key part of its health care system. Having stacked various care homes with debt in order to buy them, many private equity firms have abandoned (or are about to abandon) the homes:
[A new] report, delving into the running and funding of the care industry, reveals that the collapse of Southern Cross may not be a one-off, as a number of other social care companies are also on the brink. Private equity takeovers of public services that use similar high risk business models, could leave taxpayers picking up the bill for more company failures. The in-depth study of privatisation shows that the second largest care provider, Four Season, is also in severe financial difficulties and others may follow. If both Southern Cross and Four Seasons were to collapse, around 1,150 nursing and residential care homes would be at risk of closure, affecting nearly 50,000 vulnerable people and their families and hitting over 60,000 staff.
Another of the top four largest residential care home operators is Barchester Healthcare - a sister company to Castlebeck, the operators of the Bristol care home exposed by a Panorama documentary . . . for patient abuse . The home owners have admitted that serious wrongdoing took place at Bristol. The report shows that Barchester and other operators of care homes, have repeatedly changed ownership, often through private equity firms buying, consolidating and selling companies. The UK’s largest union is warning that the Government must tackle the crisis in the care industry.
However disruptive the private equity takeovers have been, they have fulfilled their main purpose: huge gains for a few entities that bought and sold at the right time:
Southern Cross was floated on the stock market by Blackstone, which obtained a 400% return in two years on its acquisition. Southern Cross is now at risk of collapse. Allianz Capital Partners made a return of 100% by acquiring Four Seasons in 2004 for £775 million, selling it four years later for £1.4bn - the business then collapsed in value.
3i private equity fund brought a 38% stake in Care Principles for £1.5m in 1997, the remaining amount in 2005 and sold to to Three Delta in 2007 for £270m - a return of 390%. Tunstall was acquired by Bridgepoint Capital in 2005 for £225m, merged with Bridgepoint Investment and sold on after three years for £514m.
Here are more details on Southern Cross. This story and other critical commentary suggest that the goal for owners has been rapid profit rather long term investment in more efficient processes. When the “music stopped” in the acquisition game, it was left with mounting debts.
Chris Sagers’ article “The Myth of Privatization” (59 Admin. L. Rev. 37) suggests that there is very little difference between “public” and “private” operationally, except that “one of them lacks even a nominal obligation toward the public interest.” I have seen little evidence to contradict that idea in the eldercare industry. Further research may reveal more support for Daniel JH Greenwood’s diagnosis of the rise of private equity:
The success of private equity firms challenges mainstream corporate governance theory: according to standard agency cost analysis, this should not have happened. Agency problems—the shorthand term for the tendency of fiduciaries in a capitalist system to work for themselves as well as, or instead of, their clients—cannot be solved by adding an additional layer of extremely highly paid agents supported by an ideology that justifies the most extreme forms of self-interestedness. Therefore, private equity is unlikely to be an innovative solution to the age-old agency problem.
Instead, it is better understood as a clever bit of legal arbitrage: by reclassifying agents as principals, it allows former fiduciaries to instead view themselves, and be viewed by others, as entitled to look out only for themselves. And look out for themselves they have: the private equity managers have extracted hitherto unseen sums from our corporations, appropriating for the private benefit of a handful of individuals surplus that otherwise might have gone to other corporate participants, including consumers, ordinary employees, taxpayers and investors in the public securities markets, or might have been devoted to increasing productivity or innovation for the benefit of future generations.
The basic private equity technique, like the basic hedge fund technique, appears to be to borrow money in order to increase potential returns or losses. If the loans were correctly priced, this would not create new value under standard valuation theories, nor would it be a service that could possibly warrant the high fees typically charged in the hedge fund and private equity worlds. The simplest explanation is that either lenders or fund investors are mispricing risk and have done so for several years at a stretch, contrary to the claims of the efficient market theorists.
This explanation suggests, moreover, that private equity is simply the modern equivalent of the pyramid schemes, margin loans and highly leveraged utility holding companies of the 1920s. Like those earlier edifices built on borrowed money, the contemporary schemes are likely to be highly unstable: if the underlying assets decline in value or fail to provide expected income by even small margins, the lenders are likely to take losses out of scale with their potential profits. Once lenders wake up to this possibility—most likely only after losses have begun—they are likely to cut back lending rapidly, which will, in turn, make the underlying assets both less valuable and less saleable still, thus beginning a new round of lender panic. Any minor downturn, in short, runs the risk of starting a self-reinforcing cycle of credit and business contraction. The rise of private equity in its present form, then, appears to be another step towards the pre-New Deal world of inequality and instability.
And don’t forget about the role of private equity in influencing our political process. Blackstone billionaire Pete Peterson helped fuel concerns about government spending, while doing very little to advocate for increased taxes on the wealthy. And now we see that the CLASS Act—an innovative program to promote full funding for future long-term-care in the US–is likely to be on the chopping block. The primary value of both care homes and care plans to P/E firms appears to be their susceptibility to rapid sales and purchases. The P/E firm’s employees can earn massive bonuses if the value of entities goes up, and can’t lose those bonuses even if things eventually fall apart. It is a heads they win, tails they win scenario. The losers include all the other stakeholders in firms which are treated primarily as ATMs for fleeting owners.