Daughters of Charity Health System chooses hedge fund as new owner

LOS ALTOS HILLS — The 19-month saga of the struggling Daughters of Charity Health System took a new turn today after the nonprofit hospital chain announced it will be acquired by an East Coast hedge fund that will initially infuse the chain with $250 million.

The selection of BlueMountain Capital Management comes four months after Prime Healthcare Services, the chain’s first suitor, abandoned Daughters at the altar in March, blaming “burdensome conditions” imposed by California Attorney General Kamala Harris on its $843 million offer to buy the Catholic hospital system, which is headquartered in Los Altos Hills.

Under terms of the new deal, Manhattan-based BlueMountain — not to be confused with Blue Wolf Partners, the Manhattan-based private equity fund that has now twice failed to woo Daughters — will maintain the hospital chain as a nonprofit, with an option to buy Daughters after three years. It will transfer control of the hospitals to an independent board of directors that will oversee a hospital group, owned by BlueMountain, that will manage the chain.

“In evaluating candidates to manage the hospitals, our priority was to seek the strongest bidder who could provide the greatest long-term financial stability while honoring the obligations to our associates, physicians, retirees and other constituents,” said Daughters President and CEO Robert Issai in a prepared statement.

Issai said BlueMountain’s selection ensures the communities served by the hospitals will have uninterrupted access to high quality health care, and that current and former hospital employees will see their current pension benefits remain the same. Upon the close of the transaction, all pension and retirement plans that are currently “church plans” will be required by law to become plans that are subject to the Employee Retirement Income Security Act of 1974.

And the 12-year-old hedge fund is taking on the chain with the understanding of the conditions established by Harris’s office in February.

Industry observers say that’s because BlueMountain has already benefitted from cuts that Prime had proposed — and Daughters has since implemented — to improve the chain’s balance sheet. That includes shedding almost 300 of its 7,000 workers and shuttering some unprofitable health care services at its six hospitals: O’Connor Hospital in San Jose; Saint Louise Regional Hospital in Gilroy; Seton Medical Center in Daly City; Seton Coastside Hospital in Moss Beach; and two hospitals in Los Angeles.

“Daughters did themselves a big service by undertaking those actions, because it made itself more attractive to others who won’t get saddled with all the baggage from the attorney general,” said Steve Valentine, a Southern California hospital consultant. “They’ve given more flexibility to the new buyers.”

In February, Harris — who by law must review all hospital sales in the state — allowed Prime to buy the chain, but only if it met 12 key conditions. Particularly onerous to the Southern California for-profit hospital chain was having to keep most of the facilities open as acute care hospitals for 10 years.

Prime had agreed last October to pay $150 million for capital improvement costs at Daughters’ facilities and cover pension obligations for about 17,000 current and retired employees.

Key to any deal then and now was the hospital board’s insistence that prospective buyers agree to purchase the entire chain to better manage the hospital chain’s $350 million in pension debt and $400 million in tax-exempt bonds and other liabilities.

BlueMountain — with $21 billion in assets under management and almost 22 percent of its assets in healthcare, including a few major hospital chains — is agreeing to do that.

“Blue Mountain is honored to have been selected by the DCHS board,” said BlueMountain in a prepared statement. “We are excited to provide substantial expertise and financial capital to DCHS, positioning the hospitals to meet the evolving health care needs of the region. We look forward to working with the DCHS family of physicians, employees and all stakeholders to strengthen the hospitals for the betterment of these communities.”

Experts say the health care sector is gaining traction with private equity and hedge funds that recognize a wealth of opportunities under the Affordable Care Act, which has increased the number of Americans receiving health care services.

And there’s another aim, said Stanley Altshuller, co-founder of Novus Partners, a financial research firm in New York City.

“Some hedge funds have been going into nonprofits to do greater good as well — and help turn around the image of them being ruthless profiteering or predator investors,” Altshuller said.

Private hedge funds operate with little to no regulation from the U.S. Securities and Exchange Commission. Hedge fund managers try to reduce investment risk while maintaining a good return on investment.

While Friday’s announcement was welcomed by many of Daughters’ employees and patients worried about its uncertain future, the decision isn’t final. It will take months for Harris’ office to review the proposal and gather public comment at outreach meetings, before she could sign off on the deal.

However, the news probably won’t stop the bleeding: For the nine months leading up to March 31, Daughters posted a net loss of $51.6 million and then projected a $140 million loss for 2015, though it now says that figure is being dramatically reduced because of higher Medi-Cal reimbursements than it had anticipated.

Another wound opened in March, just weeks after being jilted by Prime, when the state Department of Managed Health Care sent a “cease and desist” order prohibiting 10 major California health insurers from sending new patients to the 500-physician medical group affiliated with Daughters. The department has determined that Daughters does not comply with its minimum-solvency standards.

And others were disappointed with the announcement.

The Service Employees International Union-United Healthcare Workers West, which represents 2,675 hospital workers in the Daughters chain and worked hard to undermine the Prime deal, had hoped an updated bid by labor-affiliated Blue Wolf would prevail this time.

Over the last year, SEIU-UHW had accused the hospital chain of gutting services for low-income patients and slashing workers’ pay and benefits.

Prime and other union critics alleged that SEIU-UHW poisoned its bid with Harris, a Democrat who is counting on union support in her upcoming run for the U.S. Senate.

Reacting to today’s news, SEIU-UHW president Dave Regan said Blue Wolf would have protected critical services for local communities, “the essence of Daughters of Charity’s mission for more than 100 years.” He said his union is anxious to see the details of BlueMountain’s proposal to ensure that the “community receives the best possible health care.”

Meanwhile, Santa Clara County officials, whose offers to purchase only O’Connor and Saint Louise were never treated seriously by Daughters, said they have a partnership with O’Connor and Saint Louise to care for the county’s most vulnerable. So, they said, they hope that will continue under BlueMountain.

“The county’s priority is the welfare of our residents” said County Executive Jeff Smith. “We remain vigilant in order to assure that quality health and hospital services continue to be provided to all members of our community, independent of their financial status.”

Contact Tracy Seipel at [email protected] or 408 920-5343 and follow her atTwitter.com/taseipel.

HIGHLIGHTS OF THE DEAL * Access to $250 million in new capital to enable Daughters of Charity Health System to repay certain outstanding obligations, provide operational liquidity, and invest in physical plant improvements and operations.
* Immediate conversion of all pension and retirement plans that are “church plans” to
become subject to ERISA’s standards and requirements.
* Full assumption of current collective bargaining agreements with the hospital unions.
* Maintaining philanthropic foundations.
Source: Daughters of Charity Health System

Led by Mitch Creem and Mark Meyers, seasoned health care executives with decades of experience leading hospitals to financial stability in California and across the country.
Creem has 33 years of experience in health care management with Keck Hospital of University of Southern California; the UCLA Health System; the Beth Israel Deaconess Medical Center, a Harvard teaching hospital; and Tufts Medical Center, a Tufts University teaching hospital.
Meyers has 37 years in health care leadership roles with 22 years as a hospital CEO and nine additional years supervising multiple hospitals. Most recently he guided the formation of an Accountable Care Organization that now has 750 physician members.

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