The man behind the nation's fastest-growing hospital chain

In 2006, Paradise Valley Hospital, just 13 miles from Mexico and a world away from the luxury condos, convention hotels and craft beer bars that dot nearby downtown San Diego, faced imminent closure. The money-losing safety net hospital needed a $61 million renovation to make it earthquake-compliant.

Owner Adventist Health searched desperately for a financial savior. Only two came forward: a locally organized Paradise Preservation Group, which government officials doubted could finance the deal; and Prime Healthcare Services, a small, relatively new for-profit hospital chain owned by Dr. Prem Reddy, which offered to buy the hospital for $30 million and finance the upgrades.

During an emotional, nine-hour public hearing that drew more than 100 people, Dr. Jerome Robinson, a respected cardiologist who grew up in a Pittsburgh housing project, spoke for the community bid. He railed against a Prime takeover. “We are not-for-profit,” he said. “If we do anything with the profits that come from the sale of Paradise Valley Hospital, they need to stay in this community.”

Today, Robinson has nothing but praise for Prime and Reddy. “In order to manage and stay open, we needed to be smarter,” Robinson said. “What we've been able to see as a result of that: failing hospital eight years ago, not failing hospital today.”

Reddy's Prime deployed the same controversial tactics at Paradise Valley that it has used to become the nation's fastest-growing hospital chain, now 29 hospitals strong with deals in place for 11 more. It wrangled better rates from insurers. It added profitable services lines and implemented aggressive billing tactics.

Prime also looks inward for savings. When Prime comes in, it slashes bloated managements. It stands its ground on negotiating with unions. And it has even fought with politicians and quality raters such as Truven Health Analytics, which gives several of the chain's hospitals high marks, but in at least one case has withdrawn its approval.

The results, the company boasts, can be seen in its financial statements. Every one of its operating facilities— almost all of which were losing money when Prime took over—are now debt-free and profitable, the company claims. In almost every takeover battle, Prime has had to overcome local opposition such as that in National City, population 60,000, home of Paradise Valley hospital. “Only one person spoke in favor—and that was me,” recalled Reddy, 66, company founder and CEO. In an interview at Prime's headquarters in Ontario, Calif., the native of a small village in southern India wore a black suit with an American flag pin affixed to his lapel.

Reddy bristles when asked about his critics. But otherwise, he is at turns jovial and matter-of-fact, reducing his mission to two simple principles: “We want to save as many hospitals as we can. We want to expand in California and beyond.”

Today, Reddy's Prime is on the cusp of its biggest and most challenging takeover. It has pledged nearly $843 million, which includes debt assumption, to take on the failing finances of the six-hospital Daughters of Charity Health System, headquartered in Los Altos, Calif. The deal would add $1.3 billion in revenue to Prime's $2.5 billion, which would make it the fifth-largest investor-owned chain in the U.S.

Located in the expensive Bay Area, wages and benefits are a hefty part of Daughters' balance sheet, even as its hospitals serve some of the area's poorest communities. Many of its commercial contracts pay less than even Medicare. After talks with Ascension Health collapsed, four new bidders submitted offers; Prime's was by far the strongest.

“Its size is challenging—and I do these things for challenges,” Reddy said. “It best fits into my mission of saving the hospital, saving lives and saving jobs.”

With approval of the takeover now before California Attorney General Kamala Harris, opposition is mounting. The Service Employees International Union-United Healthcare Workers West is pressuring Harris with a full-scale media and advertising blitz accusing Prime of overbilling Medicare and Medi-Cal (California's Medicaid program), inappropriately admitting patients through its emergency departments and canceling contracts with insurers, which can lead to exorbitant out-of-network emergency department charges.

A recent SEIU video posted on YouTube paints Reddy as synonymous with corporate excess, using images of a Bentley, a Beverly Hills home, a private helicopter and luxury hotel rooms in Las Vegas allegedly paid for by government insurers. “Every time we think we've heard every example of Prime Healthcare jacking up its billings at the expense of taxpayers, we seem to find one more,” said Dave Regan, president of the SEIU-UHW.

A number of elected officials have joined the chorus. Rep. Mike Honda, a Democrat whose district includes Silicon Valley, wrote to Harris “urging her thoughtful consideration on the impact on the quality and access to healthcare when she reviews the sale of the Daughters of Charity hospitals.”

Under similar pressure in 2011, Harris blocked Prime's takeover of Victory Valley Community Hospital, citing concerns for how it would affect the availability or accessibility of healthcare services. Harris' short denial letter points to her office's own investigation, reports from consultants and advisers, and comments from “the public, the parties and potential alternative bidders.”

Prime has succeeded in turning around troubled hospitals by relentlessly focusing on delivering higher volumes of lucrative services in the most efficient manner possible. The hub of Paradise Valley, for instance, is its modern 19-room emergency department.

Like all of Prime's facilities, the hospital aims to admit patients within a two-hour timeframe or send them home within 90 minutes. Its staff closely tracks metrics such as how many people leave without being seen.

Its reputation for short waits has earned the hospital additional volume. “It actually changed the entire community,” said Dr. Paul Manos, an emergency physician at Paradise Valley, where waits once averaged 5½ hours. “It has sort of become a standard for San Diego County.”

Prime sees a competitive advantage in having patients come to its EDs instead of making the drive to another system's hospital, as it outlined in a 2011 lawsuit against Kaiser Permanente. Under the Patient Protection and Affordable Care Act, insurers must pay for basic emergency assessment and treatment services on the same basis in out-of-network hospitals as in network facilities.

Prime's lawsuit argued that Kaiser owes $100 million in unpaid medical claims and was conspiring with the SEIU to keep it out of the market. A judge dismissed the suit, but Prime is appealing.

In New Jersey, where Prime owns one hospital and is in negotiations to buy two more, insurers fear that the state's strong consumer protections tie their hands when they're hit with an inflated bill for out-of-network care. There has been a spike in for-profit hospital companies canceling insurance contracts to collect higher out-of-network fees.

“There's a concern that Prime will follow that path,” said Ward Sanders, president of the New Jersey Association of Health Plans. “There's a suspicion in the payer community that this is about billing. There's no leverage in this context. There's no limitation on what they can charge.”

But Prime counters that when a hospital is struggling, insurers have the upper hand. At one New Jersey hospital, commercial rates were 72% below Medicare, said Luis Leon, Prime's president of operations.

“In certain markets, payers can decide that a hospital is not essential,” said Joe Lupica, chairman of Newpoint Healthcare Advisors, a consulting firm. “(Reddy) gave some powerful economic resistance to the managed-care companies that they have not been used to and brought them back to the table.”

In addition to its ED strategy, Prime obsessively studies CMS billing and coding requirements and educates physicians about clinical documentation. For example, it encourages physicians to code for a specific type of heart failure, rather than the more general congestive heart failure.

“Many physicians understand quality, but they don't understand the cost,” Reddy said. “We have to give them the tools to understand those metrics. What it does is standardize the quality of care.”

Not everyone sees it that way. In 2011, a whistle-blower suit filed in Los Angeles alleged that Prime's emphasis on adding comorbidities to diagnostic codes was a way of extracting more money from Medicare—so-called upcoding. The Justice Department launched an investigation into the allegations as well as Prime's short-stay admissions practices. It opened another investigation into whether the unusually high rates of septicemia, or blood infections, and kwashiorkor, a form of severe malnutrition, among Prime's patients represented fraudulent billing practices.

But Prime insists its thoroughness on coding ultimately will be vindicated. The Justice Department declined to join the 2011 whistle-blower suit, which was unsealed last January. Suits without the department's backing are less likely to succeed.

Reddy rejects claims that Prime's physicians are encouraged to ignore the overall cost of care. He cited the example of implanting new knees or hips in young, active orthopedics patients compared to older patients in nursing homes. “At times, certain patients would not necessarily need the same prosthesis,” he said. “So someone, especially the doctor, has to be cognizant of the cost to Medicare.”

Sitting next to him at the conference table, his youngest daughter, Sunitha Reddy, vice president of hospital operations, interjects. “It's just providing information and making sure the doctor is aware,” she said.

While Paradise Valley's survival under Prime is no miracle, the hospital still celebrates its religious roots. Its walls feature the story of Ellen G. White, a member of the Seventh-day Adventist Church who purchased the property in 1904 to open a much-needed hospital despite its lack of potable water.

Believing God would provide, she ordered a well digger to go deeper and deeper until, finally, he struck water. The original well is still preserved on the Paradise Valley campus.

The hospital also touts its inclusion as one of Truven's 15 Top Health Systems in 2012 and 2013. A banner celebrating those honors hangs from one of its medical office buildings.

Yet the recognition is in jeopardy. The research firm stripped another Prime hospital, Desert Valley in Victorville, Calif., of its 2012 and 2013 awards after the hospital received a $50,000 sanction from the California Department of Health for performing non-emergency cardiac catheterizations in a lab licensed only for diagnostic procedures. One patient died and two others were injured in the 2011 incidents.

Reddy ripped Truven's decision last year after it was announced. “I have never paid a $10 fine,” he said at the time, his voice rising in anger. “That $50,000—we will never pay.”

Eleven months later, he is still vowing to fight the sanction, even though the lengthy appeals process will cost far more than $50,000. “We want it to be erased—that's why we're fighting,” he said. “Truven knows they made a mistake; they overreacted.”

Prime contends that the politically powerfully SEIU is mounting what Reddy calls a smear campaign to strong-arm the firm into recognizing the union at non-union hospitals such as Paradise Valley. In August, the chain sued the SEIU under the federal Racketeer Influenced and Corrupt Organizations Act, a law whose original intent was to prosecute organized crime.

In recent months, Reddy has stepped back from the spotlight, in part to deflect criticism from the SEIU. He is now focusing on lining up investment banks to take Prime through an initial public offering within the next two to three years.

“It's not just about money,” said Arnie Kimmel, who previously oversaw business development for Prime but left last year to become CEO of Franciscan St. James Health in Chicago Heights, Ill. “(Reddy) has said that his legacy will be a certain number—now a rapidly expanding number—of communities that would not have a hospital if it were not for Prime.”

Prem Reddy, who hails from an Indian village of 2,000 people, didn't see electricity until he went to college. But he knew he wanted to be a cardiologist from childhood, using bamboo sticks to give pretend injections.

Reddy left India in 1976 with his college sweetheart and wife of two years, Dr. Venkamma Reddy, to begin a cardiovascular disease residency in New York. Five years later, he saw an ad for a cardiologist position in the rural San Bernardino town of Apple Valley, about 90 miles east of Los Angeles. With only 7,000 people, it felt almost like home.

He immediately plunged into what in those days was one of the riskier procedures in medicine: performing angioplasties. “I practice very aggressive medicine,” Reddy said. “Those are very risky procedures and I have never constrained myself by risk.”

As his patient load grew, Reddy founded Desert Valley Medical Group in 1985. Believing he could operate profitably in the managed-care environment just then taking hold in California, he opened Desert Valley Hospital in 1994 with $7 million in private capital, including his own savings, and $15 million from a real estate investment trust.

“He broke into the scene early on when it was all about the cost containment,” said Nestor Valencia, a former managed-care executive and founder of the grass-roots organization Our Salud, a vocal opponent of the Daughters sale. “He comes in and says, 'I'll fix that.' He was tough on the doctors and he was tough on the HMOs as well.”

In 1990, Reddy established PrimeCare International, a physician-practice management company that grew to have operations in several states. He had plans to take PrimeCare all the way to an IPO but ran into a tough market. “The people who were trying to take me through an IPO said we missed the window,” Reddy said. So he sold PrimeCare and Desert Valley to another PPM, Phycor.

But the new owners mismanaged the acquisition. In 2001, Reddy decided to buy back Desert Valley. “That's when I learned exactly how to turn around a bankrupt hospital,” he said. “Of course I was scared … I was overanxious. I was everywhere—I would pull shifts in the ER.”

During those first nine months, Desert Valley lost $7 million. But by year-end, it was only $3 million in the red. In year two, it turned a profit.

The strategy was replicable. During its first decade, Prime added 11 hospitals in California. Since 2011, it has widened its net to include operations in nine states with deals in place in two more.

Inside its hospitals, Prime runs a lean operation. One of the first things it does when it takes over a facility is make deep cuts in the administrative fat. Reddy calls the management cuts “a substantial portion of our recovery.”

Prime has invested $10 million in Paradise Valley. Although it will never be a destination medical center, Prime focuses on profitable service lines.

It is building a spine and joint center. Its new orthopedics wing has 10 private rooms and was designed with a cabana theme. The unit once served pediatric patients, but Paradise Valley couldn't compete with Rady Children's Hospital 11 miles away. The hospital that once found it impossible to recruit doctors has added seven orthopedic specialists.

Attorney General Harris has until early February to approve the Daughters of Charity sale, which would apply many of the same approaches seen at Paradise Valley to its six safety net hospitals. The Catholic system's financial advisers understood the risk of rejection, but the other three options lacked Prime's financial strength and capital commitments.

“This is the superior solution to all that was available for us,” CEO Robert Issai said during an investor call. “We're very excited and the future looks very bright for us.”

Reddy says the challenging business environment in California is his main ally since Medi-Cal rates are some of the lowest in the country and the high cost of living drives up wages. “None of the major health systems want to come to California,” he said. “You can't produce a lot of profits in the practice of medicine. You have to be able to derive pleasure to save so many people and so many lives.”

Follow Beth Kutscher on Twitter: @MHbkutscher