Investors in privately held for-profit hospital chains just might be singing a song made famous by Frank Sinatra, because for them, it is a very good year.
Last week it was Nashville-based Vanguard Health Systems and its founding investor, Morgan Stanley Capital Partners, that had their year made. The Blackstone Group, a private equity firm, will buy about a two-thirds stake in Vanguard in a transaction valued at about $1.75 billion. Vanguard managers and Morgan Stanley will retain a 30% stake in the company and other investors-including not-for-profit foundations that sold their hospitals to Vanguard-will retain a stake of less than 5%, Vanguard spokesman Aaron Broad said. The deal, expected to close by Sept. 30, implies a value of about $2.5 billion for 16-hospital Vanguard, which was formed in 1997.
In May, another private equity firm, Texas Pacific Group, led a new investment team that bought Iasis Healthcare Corp., Franklin, Tenn., for $1.4 billion (May 10, p. 12). Iasis managers and the company's founding investor, JLL Partners, also remain investors in the company, which owns or operates 15 hospitals.
Like Iasis, Vanguard sees bringing in a deep-pocketed new investor as a key to boosting the company's capital and acquisition spending, Broad said. Even without bringing in the Blackstone Group, Vanguard had announced plans in May to spend about $370 million over the next three to four years at six of its hospitals in San Antonio and Phoenix. The deal gives Vanguard the ability to invest money in the 10 hospitals not covered by those plans and to pay for acquisitions, Broad said.
A spokesman for the Blackstone Group declined to comment because the deal is pending.
The private investors who are buying Iasis and Vanguard must see the potential for even greater operating performance from the two companies that could set the stage for an initial public offering of stock or a sale to another company, said Joshua Nemzoff, a healthcare transactions consultant and the principal of Nemzoff & Co.
"Blackstone has paid a significant premium for this hospital system, and it's obvious that they're betting on future performance as opposed to past performance," Nemzoff said.
Vanguard produces an operating margin-or earnings before depreciation, interest and taxes-around 10%, while the publicly traded hospital companies produce margins in the high teens, Nemzoff said, so Vanguard's management has a tough job ahead of it.
"What you have in Vanguard is a for-profit company that is run by some very experienced people that has an EBDIT margin that is equal to an average A-rated not-for-profit hospital system," he said. "The question I would be asking myself is, with a talented management team already in place, what would make you think that anybody else could get the margins up to the high teens or better?"
One common formula for valuation is that it is equal to five times the amount of cash flow. Valuing Vanguard at $2.5 billion, Nemzoff said, is paying more than double of what that formula implies for Vanguard.
Nemzoff acknowledges that the performance of the hospitals Vanguard bought in January 2003 from Baptist Health System in San Antonio could greatly improve as investments are made. The difficulty is in taking hospitals that were break-even at best and turning them into hospitals with operating margins of 20%, no matter how talented the management team is, he said.