PE-owned Health Care and Dividend Recapitalizations: Borrowing from Peter to Pay Oneself

The first half of September saw at least $8.6 billion of dividend recapitalizations, putting the month on track to be one of the largest for dividend recapitalizations since the 2008 financial crisis. Almost 24% of the money raised in the leveraged loan market in the first half of September was used for dividend recapitalizations, up from an average of 4% over the last two years.

Eileen O'Grady
Research Coordinator, Private Equity Stakeholder Project
April 6, 2021

The huge influx of federal stimulus funds into health care offered a rare window into the use by private equity of dividend recapitalization, a transaction in which private equity firms add debt to their portfolio companies’ balance sheets to finance fees and dividends for themselves without having to substantively improve operations.

Now that private equity has a firm foothold in health care, non-profit watchdog organization Private Equity Stakeholder Project (PESP) took a close look at how some of these firms are draining cash from providers of critical health services in an October 2020 report, “Dividend Recapitalizations in Health Care: How Private Equity Raids Critical Health Care Infrastructure for Short Term Profit.”

Because the portfolio companies owned by private equity are unencumbered by the reporting requirements of public companies, it is impossible to track every dividend recapitalization transaction. Companies may disclose dividends if they file with the US Securities and Exchange Commission (SEC), and ratings agencies may make note of dividends when they rate the debt used to finance them, notes report author Eileen O’Grady, research coordinator at PESP.

The report cites an analysis by Bloomberg that suggests PE-owned health care companies have received generous helpings of stimulus funding. Bloomberg found that $2.5 billion in COVID-19 aid has gone to just three private equity-backed hospital companies—LifePoint Health (Apollo Global Management), Steward Health Care (Cerberus Capital Management), and Prospect Medical Holdings (Leonard Green & Partners).

This report and a more recent analysis of how private equity has defrauded Medicare, Medicaid and other government programs is likely to reinvigorate an ongoing debate about whether dividend recapitalizations should be available to private equity firms for the purpose of generating returns from portfolio companies due to their potential to over-leverage the asset company.

The Stimulus Stimulus

The COVID-19 pandemic largely halted dividend re-capitalizations in the U.S., but the report noted a sharp uptick in the practice beginning last summer. “The first half of September saw at least $8.6 billion of dividend recapitalizations, putting the month on track to be one of the largest for dividend recapitalizations since the 2008 financial crisis,” wrote Ms. O’Grady. “Almost 24% of the money raised in the leveraged loan market in the first half of September was used for dividend recapitalizations, up from an average of 4% over the last two years.

“Given the concerns over the impact of dividend recapitalizations on the viability of companies, it is especially troubling that private equity investors would reap debt-funded dividends from their health care portfolio companies. Siphoning cash from providers of critical health services, such as hospitals, nursing homes, dental offices, mental health clinics, and others, may negatively impact affordability, quality, staffing, and access to care.”

Recognizing that health care companies draw a substantial portion of their revenue from publicly funded programs, the report makes note of the $175 billion that flowed into the industry through stimulus funding intended to address the COVID-19 pandemic by August 2020, via the Provider Relief Fund established by Coronavirus Aid, Relief, and Economic Security Act (CARES Act) and the Paycheck Protection Program (PPP) and Health Care Enhancement Act.

Five case studies detailing the effects of what it calls “aggressive financial policies” on the health of health care companies are examined in the report, which also itemizes a longer list of health care dividend recapitalizations in the appendix. This article summarizes two of those case studies.

Trident USA Case Study

Trident USA provides mobile diagnostic services to nursing homes, assisted living, hospice, and correctional facilities. In February 2019, Trident filed for Chapter 11 bankruptcy protection and subsequently paid an $8.5 million settlement as a result of a lawsuit by the U.S. Department of Justice alleging kickback schemes, but not before loading up the company with debt and paying themselves generous dividends in the years leading up to the bankruptcy.

The U.S. Department of Justice alleged that between June 2006 and September 2019, Trident engaged in illegal “swapping” arrangements in which Trident provided the skilled nursing facilities with mobile X-rays at prices below cost in exchange for referrals of federal health care business. The federal lawsuit alleged that Audax Group and Frazier Healthcare, Trident’s private equity owners between 2008 and 2013, knew about the scheme and loaded Trident with debt in order to siphon out its cash by declaring dividends and taking fees to protect their own financial interests should Trident be responsible for a large judgment or settlement under the False Claims Act. Transactions included:

·      $325 million in debt in 2012 to in part to pay the owners a $144 million dividend.

·      $236 million in proceeds when Audax Group and Frazier Healthcare sold a majority stake in the company to Formation Capital in 2013, in a sale that was partially financed with a $570 million loan to Trident.

Another dividend was paid in January 2018, a move that triggered Moody’s to downgrade Trident’s Corporate Family Rating (CFR), due to a total net leverage ratio that exceeded 7.5x—the maximum level permitted within the leverage covenant in its bank credit facilities.

Trident filed for Chapter 11 bankruptcy on February 10, 2019, and according to the report appears to have laid off at least 400 employees in the months following its bankruptcy filing. Later that year, it closed down two labs in Florida, resulting in 102 lost jobs.

Prospect Medical Holdings Case Study

During the time it has owned Prospect Medical Holdings—a safety net hospital chain operating 17 hospitals in five states—Leonard Green & Partners collected at least $658 million in fees and dividends from Prospect, despite declining financial performance, substantially under-funded pensions, and with poor quality ratings at its hospitals: of the ten Prospect hospitals evaluated by CMS, nine have a two-star rating or below and seven of the ten hospitals’ ratings have declined under Prospect’s ownership.

According to the report, Prospect has received a yearly average of $1.6 billion in Medicare and Medicaid reimbursement since 2017, roughly 55% of its annual net revenue. In addition to that, Prospect received $375 million in COVID-19 federal stimulus aid, including $234 million in loans and $141 million in federal grants. Leonard Green is now attempting to sell its majority stake in Prospect for a paltry $12 million, indicating a startlingly low valuation of the safety net hospital chain.

Prospect’s owners paid itself its biggest dividend after assuring Rhode Island regulators in 2014 that it would not pay additional dividends “in the foreseeable future.” Four years later and in a year in which Prospect generated a $244 million net loss, Prospect paid a $457 million dividend to its ownership group.

Not surprisingly, Prospect had run out of cash by 2019, as noted by Moody’s: “Prospect exited its first quarter ending December 31, 2018 without any unrestricted cash and $20 million of availability on its ABL facility.” As Leonard Green paid itself dividends, the funded ratio of the Prospect Medical Holdings’ pension funds fell from 68.3% funded to 59.9%, with an unfunded liability of $307 million by September 2019. Prospect’s pensioners are suing the company and other defendants for allegedly hiding the pension plan’s poor health to shield its liability from regulators.

The report chronicled the deteriorating situation in some detail: “In mid-2019, in an effort to pay down some of the existing $1.1 billion debt it had accrued in part to fund dividends, Prospect sold much of its hospitals’ real estate to health care REIT Medical Properties Trust and leased it back,” wrote O’Grady. “The sale-leaseback replaced debt with lease liabilities and left Prospect with fewer assets. Following the 2018 dividend Prospect’s liabilities dramatically outstripped its assets, a situation that persisted after the sale-leaseback. By the end of 2019, Prospect completely closed down all of its five health facilities in Texas, laying off nearly 1,000 workers. It then sold the downtown hospital real estate to a hotel developer.”


The report concluded with three recommendations:

·      Require greater transparency around disclosures for private equity owned health care companies.

·      Prohibit the practice of using debt to pay owners. Health care companies Limit dividends paid by health care companies to an amount that represents a reasonable share of the company’s net profit.

·      Limit the unnecessarily aggressive use of debt to pay dividends. Private equity owners of health care companies should be responsible for the debt incurred by the health care companies they own, either by imposing restrictions on additional borrowing above a set debt-to-EBITDA ratio or by requiring that private equity firms and their general partners be jointly responsible for the liabilities of their health care portfolio companies.

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