Hahnemann University Hospital

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Buy a failing hospital and profit: After Hahnemann, this could be a dangerous new playbook for rich investors

July 29, 2019 - 2:08 pm
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By Lydia DePillis, CNN Business

(CNN) — For decades, Hahnemann University Hospital served as the main safety-net hospital for downtown Philadelphia's neediest residents. But last week, it released its last patient. Within a month, the hospital's 2,572 staff will all have been laid off, and the doors will close, leaving a gaping hole in the city's ability to serve its poor — not to mention any victims of trauma, like shootings or car accidents.

"It's not safe. We're right here in the middle of everything. Jefferson (University Hospital) isn't that far, but for a life-threatening situation, minutes matter," said Maria Gutierrez, a Hahnemann oncology nurse who on Wednesday received a call from a manager saying all her shifts had been canceled. 

Joel Freedman, the California-based owner of the private equity-backed company, bought Hahnemann and its sister hospital St. Christopher's for $170 million in early 2018. About a month ago, the entity that owns the two hospitals filed for Chapter 11 bankruptcy protection, saying though St. Christopher's was profitable, Hahnemann's financial situation was unsalvageable.

Not included in the filing: The entity that owns the entire city block's worth of land underneath the hospital, as well as a few associated medical office buildings and parking garages, which Freedman had split off from the operating businesses when he and his co-investors acquired them. The same central location that made Hahnemann valuable as a health care provider — spitting distance from City Hall and the Pennsylvania Convention Center — also makes the site incredibly desirable for a high-end hotel or condominiums.

That's fueled accusations from the city, the state, the unions representing the hospital workers and even Vermont senator and presidential candidate Bernie Sanders that Freedman allowed the hospital to slip into bankruptcy, and now wants to free up the land for a potentially lucrative sale.

"There's no way he doesn't make money off the land," said Patrick Clancy, president and CEO of Philadelphia Works, the city's workforce development agency, which is now charged with helping thousands of newly unemployed workers. "He will have left our city and gone back to wherever he calls home with money in his hands and 2,400 people scrambling around."

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Freedman declined to comment for this story, noting via email "I will have a lot to say about the Hahnemann situation in a few weeks." In a statement released July 15, he said that the state of Pennsylvania had declined to provide needed financial assistance — which the state disputes — and that he remained open to any solution that would keep the hospital operating. Freedman has not commented publicly on what may lie ahead for the site.

Still, walking away from ailing businesses while profiting from their real estate is right out of the private equity playbook.

It's happened again and again in the retail and grocery sectors, which are filled with low-margin businesses that sit on land that could be more valuable if repositioned. From Toys 'R Us to Payless Shoesource, thousands of people have lost jobs when their employers are liquidated, after having been loaded down with unsustainable debt.

"The firms know that even if everything else gets wrong, there's always this real estate to sell," said Jim Baker, who runs the Private Equity Stakeholder Project, a nonprofit that advocates for people negatively impacted by private equity ownership. "That becomes part of the deal from the outset."

When it comes to a hospital, however, the stakes for the community are even higher. If the Hahnemann bankruptcy goes through as planned, advocates worry other private equity firms may try it with struggling hospitals in gentrifying neighborhoods all over the U.S.

"If you have a success like Hahnemann — that will blow up," said Eileen Appelbaum, a private equity expert who is co-director of the left-leaning Center for Economic and Policy Research. "Everybody will know that you can make money on the real estate of a hospital."

Private equity at the bedside

The drama at Hahnemann is playing out against the backdrop of a health care industry that private investors are rapidly transforming.

According to the management consulting firm Bain & Company, the global value of disclosed private equity buyouts of health care assets ranging from nursing home chains to medical device manufacturers rose to $63.1 billion in 2018, the highest level since 2006. Health care overall has higher margins than any other industry sector, Bain reports, and is seen as relatively durable in the event of an economic downturn, which is why health care buyouts as a share of all private equity deal volume has been rising as well.

It's not clear yet what that means for patients. A recent article in the Journal of the American Medical Association expressed concern that private investors tend to demand high returns in a short time frame, which can pressure physicians to push more expensive treatments over less profitable ones, and pressure hospitals to rely on medical staff who have less training.

More broadly, wrote authors Suhas Gondi and Zirui Song of Harvard Medical School, private equity firms don't have the same incentives as academic and nonprofit hospitals to use revenue streams from private insurance to subsidize indigent care and medical research. Their charge is primarily to increase profits for investors, usually by consolidating assets in a given geographic area or specialty, before selling them off.

"In the last couple years there's been a profound acceleration in private equity deals in health care," said Joseph Bruch, a Ph.D. student at Harvard studying how that trend affects patient care, on which there is little definitive research so far. "We just don't know, and it's happening very fast."

From the start, Hahnemann seemed like an odd target for a private equity investor.

Its former owner, Tenet Healthcare, had lost $15 million on Hahnemann and St. Christopher's in fiscal year 2017. Philadelphia is a very competitive market, with several large academic health systems all offering state-of-the-art facilities and vying for patients with private insurance plans.

Hahnemann, which served mostly patients insured through Medicaid and struggled to stay afloat on those low reimbursement rates, would have needed massive investment in equipment and IT systems in order to have a shot at attracting a more lucrative clientele. And health care generally has been moving away from large inpatient facilities towards smaller community-based clinics that can provide most services at a lower cost.

Freedman said he would try to turn it around. "We are thrilled and proud to be the new owners of these venerable Philadelphia hospitals and the outstanding clinical and academic programs for which they are recognized," he said in a press release, when the sale went through in 2018.

His company, American Academic Health System, is a subsidiary of El Segundo-based Paladin Healthcare, of which Freedman is the sole board member. The acquisition was financed with a $51 million loan from the investment firm Harrison Street Real Estate, and with a revolving line of credit from MidCap Financial, an affiliate of Apollo Global Management, one of the largest private equity firms in the country.

On its website, American Academic touts its management of Howard University Hospital in Washington, D.C. since 2014, saying it reduced costs and increased revenues. That contract ended in March, however, and Howard said it decided not to renew with American Academic. The other hospital system that an affiliate of American Academic managed — Avanti Hospitals, a portfolio of facilities in California that Freedman co-owned until January — agreed in December 2018 to pay $8.1 million to the federal Department of Justice to settle allegations that it submitted false claims to Medicare and Medicaid.

Ultimately, American Academic did not invest much in Hahnemann through its subsidiary, Pennsylvania Academic Health System. In bankruptcy filings, the company's restructuring offer said that Hahnemann was losing more money than the previous owner had disclosed, that its technology systems were a mess, and that it carries significant pension obligations, along with more than $100 million in debt to Drexel University College of Medicine — which used Hahnemann as its primary teaching facility — and a host of vendors. St. Christopher's was also paying monthly rent of $1.3 million to properties co-owned by Freedman and Harrison Street. On May 8, MidCap filed a notice of default, after which Pennsylvania Academic Health System tried to sell the hospitals. When that failed, it moved to take them through bankruptcy.

The city and the state tried to keep the hospital open. A spokesman for Gov. Tom Wolf told CNN Business that the state deferred taxes and offered to put Hahnemann on a payment plan, which hospital management never agreed to. Jim Engler, chief of staff to Philadelphia Mayor Jim Kenney, said that public officials had started meeting with hospital management in April to figure out a funding arrangement that would keep the hospital open, but that they were coy.

"During all that time, when we discussed the future of the hospital, we made requests for documentation to see what the real financial condition of the hospital was," Engler said. "And they never provided any of that documentation."

In a joint statement released in early July, Wolf and Kenney said Hahnemann's owners "want a bankruptcy proceeding to protect the profits they extracted from the hospital and community," and welcomed any suggestions for "how we can help mitigate the damage done by Joel Freedman and his firm."

Allen Wilen, the chief restructuring officer for the hospital, said in a statement that the talks had been fruitless. "While certain aspects of these discussions were initially promising, there were numerous conditions put forth that were unworkable," he said. Freedman blamed the state for reducing the supplemental payments the hospital had received for its Medicaid population, and according to the bankruptcy documents, a potential sale to Drexel fell through.

In a last-ditch effort, the city even ordered the hospital to stay open under a 1969 regulation that requires the city's health commissioner to sign off on the closure of an emergency room. But the hospital still stopped admissions on July 17. And there's little else the officials can do: Hahnemann is private property, and the zoning allows for many different uses, so the city doesn't have much leverage.

Who gets paid?

At this point, it's not clear that Freedman and his co-investors will be able to walk away with the full value of the real estate.

In bankruptcies like these, if creditors can prove that the debtor never really planned to try to turn around the business and simply stripped its assets, a judge may rule that they have a claim to the proceeds. In this case, that would mean the former owner Tenet, Drexel University, and other vendors may get some of their money back.

The real winner could be MidCap Financial, whose nearly $60 million in loans are secured by the mortgage on Hahnemann's main hospital building and the land underneath it, as well as the right to collect Hahnemann's unpaid bills. In the meantime, it's charging interest rates and fees that could generate millions of dollars.

Regardless of who gets paid, it's unlikely that Hahnemann will ever re-open as a full-service hospital, said Joseph Fetterman, a Philadelphia-based executive vice president at the commercial real estate brokerage Colliers International. The land could be more valuable as a hotel or condos, the health care market in Philadelphia is already oversaturated, and there's no path to profitability for a safety-net facility that needs massive capital investment.

"These hospitals close under their own weight," Fetterman said. "The value proposition of these older facilities is by natural occurrence a diminishing prospect. This will not be the last. And the real question is, how do the needs of the community get balanced with the right planning solution for the city?"

That question is actively being debated on the national stage. Sanders held a rally at the hospital in early July, using it as a backdrop to stump for his Medicare for All plan, and promising to introduce legislation that would create a $20 billion fund to help local governments purchase hospitals in financial distress.

Beyond helping struggling hospitals, Democrats are moving to clip the wings of private equity. Earlier this month, a group of lawmakers led by Massachusetts senator and presidential candidate Elizabeth Warren introduced a bill that would constrain many of the funds' activities, most notably by making the private equity firm itself liable for any debts incurred by its acquisitions.

That legislation is likely going nowhere in the Republican-controlled Senate, but stands a chance of passing if the political winds change after the 2020 election.

A system stressed

The impact of Hahnemann's closure is already starting to be felt. In the last three weeks, the emergency room at nearby Thomas Jefferson University Hospital has been seeing up to 290 patients per day, up from an average of 175. Despite added staff and building out new space, that's boosted the time from when a patient walks in the door to when they meet a provider from 13 minutes to 18 minutes. Its maternity ward has gone from a projected annual delivery rate of 1,800 births to about 2,800.

"It's been stressful," said Jefferson's president, Bruce Meyer. Complicating the issue: The vast majority of the new patients are insured through Medicaid. The state and federal government had funneled millions of dollars a year to Hahnemann to supplement low reimbursement rates. "In candor, we would need to see some of that come to Jeff to sustain the economics of this patient population," Meyer said.

About 573 medical residents who started at Hahnemann on July 1 — the day after the bankruptcy petition was filed — now have to find new places to call home for the next year. The approximately 800 nurses who were employed at the hospital have a good shot at new jobs in Philadelphia's strong health care market, said Clancy of Philadelphia Works. But with so many looking at once, many might have to travel much further or go back to school to upgrade their certifications. And at the moment, no severance money has been offered to ease the transition.

There are other kinds of disruptions from the wind-down, which has been more abrupt and chaotic than anyone anticipated.

Hahnemann oncology nurse Emma Vrancik, 26, had been scheduled to deliver her second child in August. But when she was told that her health insurance would be ending in July, having endured serious complications during her first pregnancy, she decided she couldn't take the risk of untold medical bills if something went wrong again. So she asked her doctor to induce the birth early. Her daughter, Dylan, has lost a pound since birth because of difficulty eating, and remains in the sixth percentile for weight.

"I forced my body to do something it's not supposed to do," said Vrancik, who brought the newborn to a protest outside the hospital Wednesday, and teared up talking about the difficult choice.

Still, she thinks mostly about her patients. Vrancik didn't know what to tell them when they asked her what was next for their care.

"Of course, we're all wondering, where are we gonna go," Vrancik said. "But the bigger question for us is, where are they gonna go? No one else wants the people that we treat. But we want them."

"Our patients keep coming back. We spend birthdays with them. We get them Christmas presents. We're there when they get their diagnosis, and until whatever end they have, and they're family," Vrancik continued. "We lose a paycheck. We lose our maternity leave. We lose our health insurance. But we lose a family, too."

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