Thursday, October 24, 2013

Why Equity Likes Comp

The common thinking when big money private equity moves into workers' compensation is that they are either trying to diversify portfolios to minimize risk exposure to other health care related investments or that they see profit in being able to deliver more efficiency to service delivery.

But these altruistic notions ignore the basic premise behind PE investment in my experience: short term profit regardless of obstacles.

Pharmacy benefit managers Progressive Medical and PMSI announced Wednesday that they have finalized their merger.

The deal will see H.I.G. Capital, a private equity firm, sell its interest in PMSI to private equity funds managed by Kelso & Co. and StoneRiver Group, the controlling shareholder of Progressive Medical.

According to Joe Paduda, managed care consultant and industry observer, this merger will create the largest pharmacy benefit management company in the industry with a market share of 30% to 35%.

Paduda had also blogged that MedRisk, a managed-care organization, purchased MDIA, a medical-imaging company. Paduda said that the move will allow the new entity to challenge industry leader One Call Care Management for market dominance in their sector.

In addition to these deals, other acquisitions and mergers have been happening in the past 12 months that indicate interest in workers' compensation by Big Private Equity.

KKR & Co bought Mitchell International's software business on Sept. 5. In 2012. Healthcare Solutions acquired ScripNet. One Call Care Management last year announced a deal that Reuters reported to be worth$1.5 billion to buy MSC Care Management. Harren Equity Partners closed a deal to buy MedLegal copy services earlier this year.

Some believe that these moves presage a fear in private equity firms who are vested in the health care space to diversify portfolios because of the uncertainty of the impact of the Affordable Care Act as it comes into play.

Some think that the profit motive of these companies is that based on taking advantage of basically archaic industries, reformulating the delivery of services to wring out efficiencies and profit as a consequence.

Still others believe that this money is chasing new opportunities in the consolidation of services across similar product/service lines in health care and workers' compensation.

I think that all of these arguments, while perhaps having some scintilla of accuracy, largely miss the big picture because there is a misunderstanding of private equity motivation:

Short Term Profit.

I am not a student of private equity, nor of Wall Street's ways, other than reading the Wall Street Journal every day and successfully acquiring an MBA some 17 years ago (and my interest area was marketing; finance was flummoxing to me).

And there is one theme that has constantly withstood the test of time whenever I have gone back to look at what private equity does and how they accomplish it.

There is a general formula and a short term time frame for BPE. The formula is to "purchase" a firm for an astoundingly high value, but that purchase is highly leveraged, and much of the purchase price gets tied up in an escrow account pending certain conditions and covenants.

The conditions and covenants that are contained in the purchase contracts usually are very difficult to fulfill which causes the escrow money to default back to the purchaser.

So a deal that would be worth, say, $100M on paper, after all is said and done may be worth net only half of that.

In the meantime there is management shake up, employee turn over, service interruption, and destruction of the base value upon which the business was built.

The pressure to continue with short term profit on a gutted platform is intense, and there typically is no new investment in the core of the purchased business.

I'm not saying this is the deal with the companies cited above, only that this is how money moves through The Street.

I don't believe that there is any altruism whatsoever by these firms to create a better system, or a better model or a better anything. There is no allegiance to workers' compensation or the social and economic benefits the system delivers.

And I'm not saying this is either bad or good for workers' compensation.

But it is validation that workers' compensation has a profit value to Big Money. It takes BM to move things and get action in work comp. At the same time BM can be debilitating by taking the focus away from the primary mission of the system.

Efficiency, diversification - these are just empty terms to describe another way in which people profit off of workers' compensation.

Let's just call these investment moves what they really are - complex deals calculated to derive short term profits by interests with no commitment to the long term health of the industry. Again, I'm not saying this is good or bad - it is just reality.

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