Steward’s asset-light philosophy
State's 5th-largest employer takes unusual step of selling off hospital facilities
NO ONE IS QUITE SURE what to make of Steward Health Care’s latest move.
A for-profit health care company operating in a sea of nonprofits, Steward has always been something of an aberration in Massachusetts. But now the state’s fifth-largest employer is moving far outside the mainstream. After six years trying to turn around a string of largely down-and-out hospitals, Steward is selling off its nine hospital facilities to an Alabama-based real estate investment trust and leasing them back. No other hospital in New England has gone this route before; nationally, less than 1 percent of acute care hospitals are owned by real estate investment trusts.
Steward, as usual, isn’t saying much about what it’s doing. The company issued a glowing press release when it first announced the transaction in late September, describing the sale-leaseback arrangement with Medical Properties Trust as a $1.25 billion investment in Steward that will allow the health care firm to continue to provide quality care in Massachusetts and start expanding nationally.
“We believe this investment is a strong validation of our business model and an endorsement of our ability to scale nationally,” says Ralph de la Torre, the chairman and CEO of Steward, in the press release.
Calling the infusion of cash an investment is a bit of a stretch. The primary purpose of the transaction appears to be to pay off Cerberus Capital Management, a New York private equity firm that had bankrolled Steward for six years and needed cash to pay off its investors. Steward officials and the firm’s financial advisor indicate Cerberus is collecting more than $800 million from the deal and $400 million is being used to retire debt.
Medical Properties Trust did invest $50 million in Steward, for a 4.9 percent stake in the company. But the remaining $1.2 billion is more of a business deal than an investment. The Alabama company is paying $600 million for Saint Anne’s Hospital in Fall River, Holy Family Hospital in Methuen, St. Elizabeth’s Medical Center in Brighton, Good Samaritan Medical Center in Brockton, and Morton Hospital in Taunton. The trust is paying out another $600 million and taking mortgages on Carney Hospital in Dorchester, Norwood Hospital in Norwood, Holy Family Hospital in Haverhill, and Nashoba Valley Medical Center in Ayer.
In return for the $1.2 billion, Medical Properties Trust will collect lease and mortgage payments from Steward for the next 15 years, and possibly 25 years under extension options. The initial yield on the leases and mortgages will be 10.1 percent, plus annual inflation escalators, according to a document filed with the Securities and Exchange Commission. At 10.1 percent, Steward’s first-year payment to Medical Properties Trust would total about $121 million.
As part of the deal, Cerberus is purchasing $150 million of Medical Properties Trust stock, according to the SEC document. The Steward press release says Medical Properties Trust is committed to participating in up to $1 billion of future Steward hospital acquisitions, with the Alabama company purchasing the facilities and Steward running them.
The real question now is what the deal means going forward for Steward and its more than 17,000 employees. Steward officials say they have figured out the recipe for providing high quality health care at relatively low cost, a secret sauce that the company says will lead to profitable growth nationally. The company’s financial advisor says Steward is becoming a health care operating company whose principal assets are not hospital wings and emergency rooms but a quality brand and a proven business model.
Rivals and regulators are not sure what to make of Steward shedding ownership of its hospitals. Privately, many officials at rival health care companies scoff at Steward’s claims, but none will talk on the record. State regulators also aren’t talking. Attorney General Maura Healey’s office declined comment, as did the Health Policy Commission. The Center for Health Information and Analysis says it hasn’t reviewed Steward’s hospital sale.
“We have not seen other examples of systems selling off hospitals and decoupling ownership from operations,” says spokesman Andrew Jackmauh.
The union that represents many of Steward’s employees is a fan of the health care system’s latest move. “It provides the hospital system with flexibility to expand, improve its existing infrastructure, enhance technology, and continue investing in a highly skilled health care workforce,” says Tyrék D. Lee, Sr., executive vice president of 1199SEIU United Healthcare Workers East. “We are proud of the three-year contract we recently ratified with Steward that ensures approximately 5,000 healthcare workers will continue to receive fair wages, affordable health insurance, and access to training and education opportunities.”
Running the numbers
Steward has a unique heritage. In 2010, Caritas Christi, a nonprofit health care system affiliated with the Catholic Church, sold all of its assets to Steward, a for-profit entity backed by Cerberus. Caritas was in desperate financial straits at the time, struggling with an underfunded pension plan, heavy debt, and outdated facilities. Steward promised to assume the Caritas pension liability, to keep all the hospitals open for at least five years, and to invest in the system. The transition from a charitable health care organization to a for-profit one was approved by the attorney general, in part because there was no viable alternative. Subsequent to the Caritas purchase, Steward purchased several more hospitals in Quincy, Taunton, Norwood, and Ayer and expanded its physician network from 1,000 to 3,000 doctors.
Six years later, Steward has lived up to most of its obligations. The Caritas pension system remains a major financial obligation, but the fund is intact and federally insured thanks in part to a $300 million infusion of cash. Steward says it has invested $800 million in infrastructure, technology, facilities, and services. And all of Steward’s hospitals remain open, with the exception of Quincy Medical Center, which was closed at the end of 2014 in violation of a commitment Steward made to keep the facility open until at least 2021.
Steward’s financial situation is unclear. The state’s Center for Health Information and Analysis tracks hospital financials, but it has had difficulty over the years obtaining data from Steward. Steward provided its consolidated financial statements to the center in 2012, but redacted elements of the 2013 and 2015 documents. Steward never turned over the 2014 document and has amassed $50,000 in fines for noncompliance.
The documents indicate Steward’s revenues have steadily increased, while losses have narrowed. Revenues have grown from $1.6 billion in 2011 to nearly $2.2 billion in 2015, according to the filings. Steward said in its recent press release that estimated revenues for 2016 will be $2.3 billion. The company reported operating losses from 2011 through 2014 before turning a $131.3 million profit in 2015. Without a one-time gain in 2015 from a “pension settlement,” Steward would have reported a $1 million operating loss in 2015.
Steward’s share of all patient discharges in the state in fiscal 2014 was just over 10 percent, according to data from the state Center for Health Information and Analysis. Steward’s market share was 11.8 percent for Medicare patients, 9.57 percent for Medicaid patients, and 7.96 percent for commercial patients. The share of HMO members whose primary care provider was affiliated with Steward declined slightly between 2013 and 2015 in the commercial insurance and Medicare Advantage categories and increased slightly in the Medicaid niche.
Attorney General Healey released an assessment of Steward at the end of 2015 documenting the company’s general compliance with commitments the firm made when it acquired Caritas and some of the other hospitals. But she didn’t have much positive to say about Steward’s finances.
“Overall, the financial condition of the Steward system has declined since 2012,” Healey wrote in the report. “Although the operating performance of some of its hospitals appears to have improved over time, the system’s operating losses increased as hospital expenses shifted to the parent company. The system has increasingly relied on bank term loans to fund operating losses and capital expenditures, leading to a capital structure in which debt exceeded equity by several multiples by December 2013.”
Steward prefers to focus on nonfinancial metrics when assessing its own performance. The company says it can thrive in an accountable care environment, where health care firms are not compensated for the specific services they perform but for keeping patients healthy within a set budget.
Steward says its total medical expense, adjusted for patient health status, is on a downward trend and lower than the state average in both the commercial and Medicaid markets. It says its Medicare accountable care organization is one of the top performers in the nation. And its hospital prices were well below the state median and well below those of its competitors.
Steward’s financial advisor, Cain Brothers, says in a posting on its website that the health care company has engineered a turnaround by redefining a health system’s ownership structure and growth strategy. The post, written by Cain Brothers CEO Robert Fraiman and David Johnson, the CEO of 4Insight Health, describes Steward today as an “asset-light, patient-centric health company… well positioned to compete in a post-reform competitive environment that rewards better outcomes, more efficient care delivery, and an enhanced customer experience.”
Mark Girard, president of the Steward physician network, says the company has figured out the secret sauce of health care. He says Steward oversees about 400,000 patients in accountable care programs, meaning the health care system receives lump-sum payments for the care it delivers and earns a profit or loss depending on its ability to live within that amount. (Correction: The number of patients Steward oversees was inaccurately reported in the original version of this story.)
Girard says about 4 to 5 percent of Steward patients have serious medical issues and often end up in hospitals for treatment; 15 percent have chronic health problems, such as diabetes or heart conditions that, if not monitored and treated properly, could put them in the hospital; and 80 percent are relatively healthy.
“We’ve been able to crack the code to be able to manage these populations and get the care in the right settings,” Girard says in a phone interview. “We’re an innovator in the health care marketplace and we’ve created a model that is proving to drive value.”
Girard says Steward is not a real estate company, so by shedding its hospitals it is able to focus more on its core competencies. “This is not about managing hospitals,” he says. “It’s about using the hospitals to meet your population’s health needs and managing the entire population to achieve wellness rather than just treating sickness.”
He noted Steward recently purchased the assets of a physician group in Worcester, an area where Steward has no hospital presence. He suggested the purchase was confirmation that Steward is focused on delivering care at the best possible price and not intent on putting patients in its hospital beds.
Fraiman and Johnson, in their post on the Cain Brothers website, say Steward is following the lead of the hospitality industry. “Major hotel chains rarely own their facilities. They lease properties from real estate companies. They realized a long time ago that buildings are not the key to their success. Instead, customer relationships are the true foundation of their success,” they say. “Marriott, Hyatt, Hilton, and other hotel chains are ‘asset-light.’ They compete based on their brands, services, customer experience, loyalty programs, and market positioning. As health care becomes more consumer-oriented, health systems must develop equally strong brand loyalty and customer relationships.”
Having sold off its nine hospital facilities and earlier its medical office buildings, Steward is indeed asset-light. But some health experts say Steward remains on the hook financially for the hospitals.
“There’s no free lunch,” says Alan Sager, a professor of health law, policy, and management at Boston University. “Medical Properties Trust is expecting a substantial return on its investment. How will Steward be able to finance that return? By a combination of higher prices, higher volume, and lower cost of health care it delivers.”
Paul Levy, the former head of Beth Israel Deaconess Medical Center in Boston, says the deal between Steward and Medical Properties Trust has less to do with health care than it does with extracting cash from the business to settle up with Cerberus. “These are just financial transactions,” he says.
Paul Hattis, an associate professor at Tufts University who previously served on the board of the Health Policy Commission, says Steward does appear to be embracing its role as a health care management organization working to deliver care at low cost and less focused on defending capital investments in hospitals.
“They’re banking on their ability to be good managers of global budgets,” he says, referring to the lump sum payments accountable care organizations receive. “But there’s still a lot of uncertainty about the viability of the business model.”One big unknown is President Trump, who has said he intends to do away with the Affordable Care Act, which places a premium on the accountable care model. Asked what repeal of the law would mean for Steward, Girard doesn’t answer directly. He says Steward’s care delivery system provides real value and would work well under any compensation scheme. “It’s replicable and I think it’s valuable,” he says.