Private equity investors in healthcare finally face the music

Private equity investors in healthcare finally face the music as their highly leveraged companies face downgrades and defaults on a large-scale

Private equity’s use of debt to fund its healthcare investments is becoming a major liability for its portfolio companies as interest rates rise and the cost of labor skyrockets.[1] In December 2022, Moody’s Investors Service found that of the 193 North American healthcare companies that it rates, 34 faced rating downgrades and potential defaults. Of those 34 companies, 30 (88%) were owned or controlled by private equity firms.[2]

The disproportionate amount of private equity-owned companies on the list is not a coincidence. Rather, it’s directly related to the outsized debt burdens these companies face due to the excessive leverage placed on them at the time they were acquired by private equity investors, as well as debt sometimes placed on them post-acquisition in order to fund add-on acquisitions or investor dividends.

For years, the healthcare sector has had a reputation of being recession-proof among private equity investors.[3] This reputation stemmed from the high demand for healthcare services that continues to rise even higher as the U.S. population ages and is increasingly burdened by chronic disease. Fragmentation within healthcare subsectors has also attracted investors hoping to generate value through consolidation by using platform companies to roll-up smaller companies into large powerhouses that they can then sell at a much higher price.[4]

The private equity playbook generally involves acquiring companies through leveraged buyouts (i.e. funding the acquisition through typically 70% debt vs. 30% equity, with the debt saddled onto the company being acquired). The investors aim to cut costs and increase cash flow at these companies, and after a period of around 3-7 years, either take them public or sell them to other private investors.[5]

These high debt burdens have made it difficult for companies to dynamically respond to a changing regulatory landscape and volatile market conditions while meeting their debt service obligations. The impacts of debt go beyond the financial viability of the company in question; debt service obligations can also lead to cost-cutting that negatively impacts healthcare workers and patient care.

In February 2023, Bloomberg published an article detailing how the healthcare industry has transformed under increased private equity investment, arguing: “Healthcare companies used to be some of the safest to lend to during economic downturns, until private equity firms bought them out and larded them with debt. Now they’re some of the riskiest borrowers in the world of leveraged loans.”[6]

Envision Healthcare, U.S. Renal Care, and Athletico Physical Therapy provide informative examples of how unwieldy debt burdens can lead to credit downgrades, defaults, and even bankruptcies.

Envision Healthcare to reportedly file for Chapter 11 bankruptcy
Envision Healthcare, owned by KKR, offers perhaps the starkest example of an over-leveraged company that has not been able to adapt to changing regulations and market conditions. On May 15, 2023, WSJ reported that Envision had filed for Chapter 11 bankruptcy. For those following Envision’s saga, this is no surprise.[7]

But before Envision drew scrutiny for its financial situation, it was drawing scrutiny for its use of surprise billing. Envision’s business model has historically relied on the inelastic demand of emergency medical care coupled with a strategy of out-of-network billing to charge much higher than average rates to patients via surprise bills.[8] It lobbied extensively (spending millions of dollars via a dark money campaign) to prevent federal regulations that would limit the practice,[9] but ultimately failed when the No Surprises Act became law in December 2020[10] and went into effect in January 2022.[11]

Despite collecting $275 million in CARES Act funds as of June 2021,[12] Envision was in financial trouble the following year. On September 21, 2022, Moody’s Investor Service downgraded Envision Healthcare to its lowest corporate credit rating. In its rating report, Moody’s explained:

“With respect to governance, Envision Healthcare has an aggressive financial strategy characterized by high financial leverage, shareholder-friendly policies, and the pursuit of acquisitive growth. This is largely due to its private equity ownership by KKR since its leveraged buyout in 2018. Lastly, the company executed a distressed exchange in April 2020, April 2022 and again in July 2022.”[13]

A look at the various financial maneuvers undertaken at Envision under KKR’s ownership help paint a better understanding of the “aggressive financial strategy” cited by Moody’s and how Envision has arrived at the place where it is today.

When KKR acquired Envision in 2018 for $9.9 billion via a leveraged buyout,[14] it used about $7 billion in debt to do so—approximately 70.7% of the deal value. This debt was not taken on by KKR, but rather loaded onto Envision.[15] Reuters reported that “KKR’s takeover of Envision for US$9.9bn…was one of the largest leveraged buyouts since the financial crisis.”[16]

Using high amounts of leverage to acquire Envision turned out to be a major risk when market conditions suddenly changed with the onset of the pandemic, and as the regulatory landscape around surprise billing began to shift. Envision also found itself embroiled in costly litigation with insurer UnitedHealthcare. Throughout these headwinds, Envision still had to meet its debt obligations even as its revenues were dropping.[17]

Envision’s financial situation has worsened since the September 2022 ratings downgrade from Moody’s. It missed a March 31, 2023 reporting deadline for its quarterly financials,[18] and then missed a $40 million interest payment in April.[19]

In March, Envision announced it would lay off 167 New York employees, and announced another layoff of 162 workers in Pennsylvania in May.[20] Most of Envision’s $7 billion in debt has been trading below 10 cents on the dollar in recent weeks.[21]

Under KKR’s ownership, Envision has transformed from a profitable company and desirable acquisition target purchased in one of the largest leveraged buyouts since the financial crisis to a financially distressed one that has filed for bankruptcy and is facing reputational fallout from its business practices.

Envision Healthcare’s extractive business model of surprise billing that can saddle medical debt onto patients has come full circle as Envision enters bankruptcy itself, saddled with debt by its private equity owner.

Yet, unlike the ordinary Americans who may end up in life-changing bankruptcies because of their medical debt, Envision’s private equity investors will likely come out relatively unscathed.[22] Even if KKR loses its ownership stake in its Chapter 11 bankruptcy, according to WSJ, “The KKR fund Envision is in has already written off the investment and still has a net annualized return of 19%, according to people familiar with the matter.”[23]

In addition to Envision, KKR also owns or backs three other companies that made it to Moody’s December 2022 list of healthcare companies facing credit downgrades and defaults: Air Methods, Covenant Physician Partners, and One Call Corporation.[24]

Saddled with debt, U.S. Renal Care remains vulnerable to shifting market conditions
U.S. Renal Care provides another example of a company made vulnerable by its debt load amidst shifting market conditions (and a potentially shifting regulatory landscape).

U.S. Renal Care is one of the largest dialysis providers in the U.S.[25] According to its website, the company “serves more than 26,000 patients across 32 states in more than 400 facilities providing in-center and home dialysis.”[26]

It has been backed by various private equity firms since 2005, which have collectively saddled the company with hundreds of millions in debt.[27] It is currently owned by a private equity investment group consisting of Bain Capital, Summit Partners, Revelstoke Partners, along with other investors and management which acquired it in 2019.[28]

According to Bloomberg, the “company has been squeezed by the pandemic, which increased death rates among patients and intensified staffing shortages.”[29] Its $1.6 billion term loan due in 2026 was trading at 57.4 cents on the dollar as of May 17, 2023, down from 81.5 cents a year ago.[30]

Moody’s last rated U.S. Renal Care in June 2022, when it downgraded its corporate family rating to Caa1 from B3. It cited “very high financial leverage and weak operating performance” as factors contributing to the downgrade, and predicted that the company’s leverage would remain “very high with debt/EBITDA above 8 times over the next 12 to 18 months.”[31]

The rating rationale also cited ESG considerations, explaining “Various states have pursued legislation, that if passed, could reduce the company’s and other dialysis companies’ profits… Among governance considerations, U.S. Renal’s financial policies under private equity ownership are very aggressive, reflected in high debt levels.”[32]

Athletico Physical Therapy continues its debt-financed expansion despite poor credit ratings
Athletico Physical Therapy has over 900 locations across 24 states and the District of Columbia, and nearly 8000 employees as of July 2022.[33] It is backed by BDG Capital Partners, which purchased a stake in the company in 2016.[34] Since BDG’s acquisition, Athletico has made at least 11 add-on acquisitions.[35] It has also opened up new locations, including 19 in the first five months of 2023.[36]

The company is highly leveraged, most recently having taken out an $875 million term loan to fund its acquisition of Pivot Health Solutions and to add cash to its balance sheet.[37]

On March 24, 2023, Moody’s Investors Service downgraded Athletico’s Corporate Family Rating to Caa1 from B3. In its rationale, Moody’s cited excessive leverage and Athletico’s expansion strategy, writing,

“Moody’s estimates that debt/EBITDA was approximately 10x for the twelve months ended December 31, 2022 on a Moody’s adjusted basis. Moody’s forecasts leverage will remain elevated and above 8.5x over the next 12-18 months…The rating also reflects the relatively low barriers to entry in the physical therapy business and the risk of market oversaturation given the rapid expansion of Athletico and many of its competitors. The rating also incorporates risks associated with the company’s rapid expansion strategy as it grows, both organically and through acquisitions.”[38]

What’s next?
Many private equity firms now must face the music for the cheap debt they used to acquire healthcare companies in recent years. This may even involve major restructurings or bankruptcies for some companies.

But patients and healthcare workers will likely face the greatest impacts from the high debt burdens of private equity-backed companies. Debt service obligations have the potential to lead to cost-cutting, and in healthcare, there are few ways to cut costs without impacting patient care and the workers who care for them.

[1] Butt, Rachel, and Carmen Arroyo. “Health-Care Debt Gets Harder Look as Distress Builds.” Bloomberg.Com, February 8, 2023. https://www.bloomberg.com/news/articles/2023-02-08/healthcare-debt-gets-harder-look-as-distress-builds-prices-drop.

[2] O’Grady, Eileen. “Almost 90% of Most Distressed Healthcare Companies Are Owned by PE Firms.” Private Equity Stakeholder Project (blog), January 3, 2023. https://pestakeholder.org/news/almost-90-of-most-distressed-healthcare-companies-are-owned-by-pe-firms/.

[3] Butt, Rachel, and Carmen Arroyo. “Health-Care Debt Gets Harder Look as Distress Builds.” Bloomberg.Com, February 8, 2023. https://www.bloomberg.com/news/articles/2023-02-08/healthcare-debt-gets-harder-look-as-distress-builds-prices-drop.

[4] Bugbee, Mary, Eileen O’Grady, and Michael Fenne. “Recent Trends in Private Equity Healthcare Acquisitions.” Private Equity Stakeholder Project. Accessed March 15, 2023. https://pestakeholder.org/wp-content/uploads/2023/02/PESP_Report_HC_Acquisitions_Feb2023_FINAL.pdf.

[5] Pg. 2; Matthews, Sajith, and Renato Roxas. “Private Equity and Its Effect on Patients: A Window into the Future.” International Journal of Health Economics and Management, May 23, 2022, 1–12. https://doi.org/10.1007/s10754-022-09331-y.

[6] Butt, Rachel, and Carmen Arroyo. “Health-Care Debt Gets Harder Look as Distress Builds.” Bloomberg.Com, February 8, 2023. https://www.bloomberg.com/news/articles/2023-02-08/healthcare-debt-gets-harder-look-as-distress-builds-prices-drop.

[7] Gottfried, Miriam, and Alexander Saeedy. “WSJ News Exclusive | KKR-Backed Envision Healthcare Plans Chapter 11 Bankruptcy Filing.” Wall Street Journal, May 9, 2023, sec. Markets. https://www.wsj.com/articles/kkr-backed-envision-healthcare-plans-chapter-11-bankruptcy-filing-2fff4382.

[8] Cooper, Zack, Fiona Scott Morton, and Nathan Shekita. “Surprise! Out-of-Network Billing for Emergency Care in the United States.” Cambridge, MA: National Bureau of Economic Research, July 2017. https://doi.org/10.3386/w23623.

[9] Arnsdorf, Isaac. “Medical Staffing Companies Cut Doctors’ Pay While Spending Millions on Political Ads.” ProPublica, April 20, 2020. https://www.propublica.org/article/medical-staffing-companies-cut-doctors-pay-while-spending-millions-on-political-ads

[10] American Medical Association. “Implementation of the No Surprises Act.” Accessed October 26, 2022. https://www.ama-assn.org/delivering-care/patient-support-advocacy/implementation-no-surprises-act.

[11] CMS.gov. “Surprise Billing & Protecting Consumers.” CMS.gov, January 14, 2022. https://www.cms.gov/nosurprises/Ending-Surprise-Medical-Bills.

[12] Moody’s Investor Service. “Moody’s Affirms Envision Healthcare’s CFR at Caa2; Outlook Changed to Stable.” Moodys.com, October 18, 2021. http://www.moodys.com:18000/research/Moodys-affirms-Envision-Healthcares-CFR-at-Caa2-outlook-changed-to–PR_456377.

[13] Moody’s Investor Service. “Moody’s Downgrades Envision Healthcare Corporation to C, Outlook Stable.” Moodys.com, September 21, 2022. http://www.moodys.com:18000/research/Moodys-downgrades-Envision-Healthcare-Corporation-to-C-outlook-stable–PR_469479.

[14] Stinnet, Joel. “Envision Healthcare Completes $9.9 Billion Sale to KKR.” Nashville Business Journal. October, 11, 2018. Accessed October 13, 2022. https://www.bizjournals.com/nashville/news/2018/10/11/completion-of-9-9b-deal-leaves-nashville-with-one.html.

[15] Ronalds-Hannon, Eliza, and Davide Scigliuzzo. “The Debt Deal That Shows How Ugly Things Are Getting for Lenders.” Bloomberg.Com, October 5, 2022. https://www.bloomberg.com/news/articles/2022-10-05/kkr-s-envision-deal-shows-how-ugly-creditor-battles-are-getting.

[16] Brooke, David, and David Weinman. “Envision US$5.45bn TLB Sinks as US Healthcare Debate Rages.” Reuters, August 28, 2019. https://www.reuters.com/article/envision-us545bn-tlb-sinks-as-us-healthc-idCNL2N25O14W.

[17] Bugbee, Mary. “Envision Healthcare: A Private Equity Case Study.” Private Equity Stakeholder Project, December 2022. https://pestakeholder.org/wp-content/uploads/2022/12/Envision_CaseStudy_Final_Dec2022.pdf.

[18] Gottfried, Miriam, and Alexander Saeedy. “WSJ News Exclusive | KKR-Backed Envision Healthcare Plans Chapter 11 Bankruptcy Filing.” Wall Street Journal, May 9, 2023, sec. Markets. https://www.wsj.com/articles/kkr-backed-envision-healthcare-plans-chapter-11-bankruptcy-filing-2fff4382.

[19] Shi, Madeline. “KKR’s Equity at Risk in Envision Healthcare Debt Restructuring Talks | PitchBook,” April 20, 2023. https://pitchbook.com/news/articles/KKR-Envision-Healthcare-PE-debt-equity.

[20] Condon, Alan. “Envision Plans Layoffs in New York, Pennsylvania.” Becker’s Hospital Review, May 11, 2023. https://www.beckershospitalreview.com/finance/envision-plans-layoffs-in-new-york-pennsylvania.html.

[21] Gottfried, Miriam, and Alexander Saeedy. “WSJ News Exclusive | KKR-Backed Envision Healthcare Plans Chapter 11 Bankruptcy Filing.” Wall Street Journal, May 9, 2023, sec. Markets. https://www.wsj.com/articles/kkr-backed-envision-healthcare-plans-chapter-11-bankruptcy-filing-2fff4382.

[22] Appelbaum, Eileen, and Rosemary Batt. “Envision Healthcare Hits the Skids.” The American Prospect, March 14, 2022. https://prospect.org/api/content/dee32e40-a176-11ec-bb52-12f1225286c6/; Ronalds-Hannon, Eliza, and Davide Scigliuzzo. “The Debt Deal That Shows How Ugly Things Are Getting for Lenders.” Bloomberg.Com, October 5, 2022. https://www.bloomberg.com/news/articles/2022-10-05/kkr-s-envision-deal-shows-how-ugly-creditor-battles-are-getting.

[23] Gottfried, Miriam, and Alexander Saeedy. “WSJ News Exclusive | KKR-Backed Envision Healthcare Plans Chapter 11 Bankruptcy Filing.” Wall Street Journal, May 9, 2023, sec. Markets. https://www.wsj.com/articles/kkr-backed-envision-healthcare-plans-chapter-11-bankruptcy-filing-2fff4382.

[24] O’Grady, Eileen. “Almost 90% of Most Distressed Healthcare Companies Are Owned by PE Firms.” Private Equity Stakeholder Project (blog), January 3, 2023. https://pestakeholder.org/news/almost-90-of-most-distressed-healthcare-companies-are-owned-by-pe-firms/.

[25] “Top 6 Companies Leading the Global Dialysis Market,” November 25, 2022. https://www.expertmarketresearch.com/articles/top-dialysis-companies; Pringle, Sarah. “U.S. Renal, Backed by Leonard Green, Frazier Healthcare, Explores Sale.” Content. PE Hub (blog), December 18, 2018. https://www.pehub.com/u-s-renal-backed-by-leonard-green-frazier-healthcare-explores-sale/.

[26] U.S. Renal Care®. “About.” Accessed April 20, 2023. https://www.usrenalcare.com/about/index.html.

[27] Sergie, Mohammed Aly. “Leonard Green to Buy Majority Stake in Dialysis Center Operator U.S. Renal Care.” Wall Street Journal, June 22, 2012, sec. Pro Venture Capital. http://www.wsj.com/articles/DJFVW00020120621e86lprwj5.

[28] PitchBook. “PitchBook Profile – U.S. Renal Care – Deal History.” Accessed April 20, 2023. https://my.pitchbook.com/profile/10286-83/company/profile#deal-history/116411-32T; U.S. Renal Care®. “U.S. Renal Care,” March 13, 2019. https://www.usrenalcare.com/media/press-release/investor-group.html;

[29] Butt, Rachel, and Carmen Arroyo. “Health-Care Debt Gets Harder Look as Distress Builds.” Bloomberg.Com, February 8, 2023. https://www.bloomberg.com/news/articles/2023-02-08/healthcare-debt-gets-harder-look-as-distress-builds-prices-drop.

[30] Bloomberg, historical pricing data for US Renal Care term loan due July 2026, BL3003243. Accessed May 17, 2023.

[31] Moody’s Investors Service. “Moody’s Downgrades U.S. Renal Care, Inc’s CFR to Caa1; Outlook Stable | Rating Action | Moody’s.” moodys.com, June 28, 2022. https://www.moodys.com/research/Moodys-downgrades-US-Renal-Care-Incs-CFR-to-Caa1-outlook-Rating-Action–PR_467275.

[32] Moody’s Investors Service. “Moody’s Downgrades U.S. Renal Care, Inc’s CFR to Caa1; Outlook Stable | Rating Action | Moody’s.” moodys.com, June 28, 2022. https://www.moodys.com/research/Moodys-downgrades-US-Renal-Care-Incs-CFR-to-Caa1-outlook-Rating-Action–PR_467275.

[33] Athletico. “Physical Therapy Clinic Locations – Athletico Locations.” Accessed May 10, 2023. https://www.athletico.com/locations/; Athletico Physical Therapy. “Athletico Physical Therapy Expands Presence in Mississippi and Oklahoma,” July 28, 2022. https://www.prnewswire.com/news-releases/athletico-physical-therapy-expands-presence-in-mississippi-and-oklahoma-301594510.html.

[34] Channick, Robert. “Investment Firm Buys Stake in Athletico to Fund Expansion.” Chicago Tribune, November 16, 2016. https://www.chicagotribune.com/business/ct-athletico-investment-expansion-1117-biz-20161116-story.html.

[35] PitchBook. “PitchBook Profile – Athletico Physical Therapy.” Accessed May 10, 2023. https://my.pitchbook.com/profile/63355-60/company/profile#lead-partners.

[36] Athletico. “Athletico Physical Theray Press Releases,” 2023. https://www.athletico.com/our-company/press-room/press-releases/.

[37] S&P Global. “Athletico Physical Therapy Completes $875M Term Loan at Tight End of Talk; Terms,” February 3, 2922. https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/athletico-physical-therapy-completes-875m-term-loan-at-tight-end-of-talk-terms-68731419.

[38] Moody’s Investors Service. “Moody’s Downgrades Athletico’s CFR to Caa1; Outlook Is Stable | Rating Action | Moody’s.” moodys.com, March 24, 2023. https://www.moodys.com/research/Moodys-downgrades-Athleticos-CFR-to-Caa1-outlook-is-stable-Rating-Action–PR_475192?cy=asia&lang=en.