Sunday, May 16, 2010

The Carlyle Group's Leasebacks in the Outback?

Carlyle Group co-founder William E. Conway, Jr. recently warned Australia on tax predictability. Yet, his private equity underwriting (PEU) firm bid on Healthscope, an Australian for-profit hospital chain. The Australian reported:

A JPMorgan analyst said the potential new owner could sell some property to pay for growth or reduce debt. ( I covered this in a prior post)

"Motivation for private equity interest could be to separate the hospital operating company and the hospital land, and to divest the hospital property to pay down debt," the analyst said in a research note.

"We feel that sale and leasebacks could be used by private equity to streamline Healthscope's hospitals."

Streamline? More like milk. Carlyle split Manor Care's real estate and long term care operations. It sold commercial mortgage backed securities (CMBS), thus providing a source of capital for the deal. It conducted a "sale and leasebacks."

"Sales" occur at enhanced valuation levels. Thus, "leasebacks" mean higher lease rates, which are passed on to the health care operations division. In America such costs roll up into Medicare cost reports, a major basis for government reimbursement. Uncle Sam pays a healthy chunk of increased facility costs. Such costs become the basis for hospital negotiations with private insurers.

Separating real estate and health operations adds a liability advantage. In the case of malpractice lawsuits, the deep pocket is much shallower without the value of a hospital building.

William Conway hates a level playing field, as well as paying taxes. But he is happy to engineer schemes milking the federal government on behalf of Carlyle's health care affiliates.

Carlyle's ManorCare benefited from an Obama stimulus tax break for companies buying back debt for pennies on the dollar. In the double win, Conway purchased discounted debt with preferred tax advantages.

I expect Bill to extend the same discourtesy to Australians. It remains to be seen how PEU chaired government reform efforts will change the U.S. table, already tilted in favor of PEU's. Using financial reform's PEU free pass as my guide, I won't hold my breath for change.

Carlyle and company may have to kick in more change, should Healthscope demand a higher bid.