Classic Deal: HCA – Chris Gordon, Bain Capital (EP.335)

25:43And we found a few more dollars in our pocket and came back and we had a good back and forth, but we eventually got to a price that the board was willing to accept. And we were willing to swallow hard and stand behind, which is they say is probably the sign of a good negotiation when everybody feels really nervous with the outcome in a balanced kind of way. So we were really excited, but we definitely leaned into purchase prices probably well beyond where we thought we were going to need to be when we walked into this whole thing in the first place. How many times did you guys go back and forth in that discussion?

26:13It was probably two or three concrete proposals back and forth, obviously with lots of different smaller conversations alongside of those. And if you pulled out your negotiating class from business school, Do you remember any of the dynamics as you were getting close to the end that you said, okay, how are we going to get from where we are to getting this thing agreed? I do sort of remember my business school negotiating class, and I'm not sure that really came into play here, for me at least, because one of the things that's liberating sometimes in a negotiation is just literally knowing where your last dollar is and getting to the point where you just need to put it on the table.

26:54Because look, as much as we love this company and this opportunity, we're also in the business of trying to deliver really good returns to our investors. And so we build our models and we do our math and they're never perfect, but we do our best to think about what is the right risk return opportunity. And we come to a maximum price that we're willing to pay. And of course, then our job is to pay as far below that maximum price as possible. But I do think that this, to us, felt like a case, and maybe they were doing a great job in negotiating. I never knew what their reservation price really was, But the board did a good job of convincing us that at our initial bid, where, like I said, we did have a little bit of room left, they weren't going to transact.

27:30And so we came back a couple times. But when we finally came back with our final proposal, it was literally our last dollar, probably even a little bit beyond what we thought our last dollar was going to be. I've been in a few of those negotiations where the other side, either because they're tactical and smart or because substantively they're in the same place, gets me to the point where I'm at as high as I'm willing to go. And in this case, we had a consortium. So it had to be as high as we were all collectively willing to go. And then you just find out if there's a transaction opportunity there.

27:59And that's in a lot of ways, that's sort of the easiest way to finish a negotiation because like, okay, well, we are where we are. And if you like this, we'd love to do this transaction. If you don't, we appreciate the time and let's stay in touch. How did added layers of complexity come into that discussion because it was a group consortium of buyers? In a theoretical sense, anytime you have more parties around the table, it's always a little harder and a little more complicated. We've always found that to be a pretty good dynamic for us. And we found the KKR team and certainly the Frist family and the Merrill Lynch team to be really good partners in all of this because nobody was really showing up with a lot of ego or need to be the one who was right or need to be the one who is the loudest voice at the table, including, by the way, the Frist family.

28:43They're the ones who probably would have had the most right to do that. But they're just an incredibly smart but humble group of people who's always willing to listen to good ideas from others. And so it ended up just being a very consensus-driven process. I've done a decent number of consortium transactions over time, and I've just found it to be an asset in the investing business to be open to the types of dialogue and compromise that you need to be able to make to have effective consortium dynamics. And that in the long term, there's a lot of investment value that can be created by having healthy dynamics around the table.

29:18And so we certainly had a lot of conversations, but the nature of those conversations tended to be, okay, if there's a question or a difference of opinion over an issue, let's just figure out what more work we can do, what more facts we can bring to the table to try to get to a good place there. Once you bought the business, were there aspects of the operational game plan that the Frisk family thought they could implement on being private that they hadn't been doing as a public company? As a general matter, public company boards have the same objective as anybody, which is you want to create, obviously, good value for your customers, good value for your employees, and good value for your investors.

29:58But I do think that the nature of trying to deliver value to public company shareholders does get more complicated by the need to always drive your quarterly results on an ongoing basis. And look, there's plenty of public market investors who have long-term orientation, but there's also a subset of the public market that is a little more short-term oriented and tries to invest around some of those nearer term quarterly dynamics. And it is in some cases painful for public companies to have a lot of volatility around their stock price. It can be disconcerting to your employee base when you see your stock price moving around.

30:37And so even if with the best of intentions, I think a lot of public companies find themselves having to manage around some of those shorter term dynamics when I think for the most part, they would much rather be focused on what are the long-term investments I need to make. And over time, that will deliver good short-term results as well. But most businesses aren't so linear that you don't have some amount of volatility around the mean, even if it's just all heading in the right direction. And so in a case like HCA, what it generally lets you do is it tends to let you take actions more quickly operationally, even if that might lead to some shorter-term volatility in your results.

31:18If you decided on a course of action, and it's going to lead to come X, Y, or Z by year five, in a public company setting, you might blend into that over time. In a private company setting, if it's the right thing to do, you do it all at once and accept the fact that that could create a little bit of disruption, but you're doing it for that long-term gain. This actually wasn't a case where we had a lot of very transformative initiatives in mind. HCA was a well-run company. And so this was much more a story about just really focusing on a longer list of tactical optimizations with the idea that driving that kind of performance will help re-educate some future buyer universe, whether public or otherwise, around the power of this kind of a platform relative to what had been some of the perceived headwinds around some of the short-term emissions or uncompensated care volatility.

32:14Two years into this transaction, you run into the financial crisis. And you had mentioned two phrases that called to mind, I wonder what happened. One is bad debt risk, and the other is Merrill Lynch. So I would love to hear what was that experience like when you hit the financial crisis for HCA? The good news is the bad debt risk that I referenced earlier are related to patient bad debt, so uncompensated care. So that wasn't our balance sheet. But you raise a good question, which is we had a lot of debt on our balance sheet. Now, the good news is when you put these types of LBO transactions in place, you generally have reasonably long time frames on your debt and plenty of cushion if you've underwritten appropriately around your operating cash flows and what you're going to need to service that debt, or maybe not plenty of cushion, but enough for it to be appropriate within the context of the operations of that kind of a business.

33:08So we head into the financial crisis. Day one, that didn't affect our balance sheets. Our balance sheet was all underwritten and put in place, and we'd swapped out our interest rates. And so we had what we had from a balance sheet perspective. The business had been performing well, so it was generally on plan. But at the same time, you're looking forward and you're thinking, okay, well, at some point, we will need to either exit this business or go public, and we're going to need to refinance all this debt. And if the debt markets are in a really bad spot, that could be a challenge. Now, the good news is that was still years out before we really had to be worrying about those dynamics, but it certainly hit the boardroom conversation set, which is, okay, we're dealing with a very different world from a debt financing perspective now than we were back in late 2006 when we put this financing in place.

33:59So what are all the things that we need to be doing over the next several years to be prepared for what could be a much more challenging refinancing environment as this debt all matures? Now, a lot of different factors played out over time. We did go public, so that created a delevering event. The debt markets improve a lot between 2008 or 2009, which is when we would have been having this conversation, and 2011 or 12, which is really when our debt started to mature. What happened to, say, the left side of the balance? Hospital businesses are not recession immune, but they are fairly recession insensitive because you're delivering healthcare and people, well, maybe some larger portion of the population might lose their insurance coverage during a recession.

34:42There is good safety nets in many cases for coverage. And so hospitals don't tend to face too much in the way of volume headwinds, but still there are some challenges. As we headed into the recession component, the part that would really affect the operating side of HCA, we certainly had some concerns. But one of the things that we had started working on, which ended up being pretty impactful, was a bit of a shift in operating mindset at HCA. And look, I'm always happy to claim credit when the private equity investors are the ones that drive something. Full disclosure, this was really driven by the management team and really Richard Bracken.

35:16And we were highly supportive and we found some ways to help. But the initiative was really around, how can we create more central value to this network of 160 hospitals that we have? Because the historical HCA philosophy had largely been around, we really want to have great local market, local hospital CEOs and leadership, but that's really how you create value and drive good performance in hospitals. The center really doesn't need to be doing all that much. The mindset shift was that, well, of course, having strong local leadership in our hospitals is incredibly important, but the center can provide some tools to really help optimize that care delivery and those operations in the hospital systems.

36:00Not that all of a sudden HCA was going to become command and control and we're going to run all the hospitals from Nashville, but Nashville could provide a lot in terms of sharing best practices around the systems, developing sets of key performance indicators to really help all the different hospitals across the network understand where they might have the ability to drive more efficiency amongst their operations. What are the right service offerings within a hospital that attract the most physicians and make patients want to come there? One really interesting example actually was around emergency room optimization.

36:34And they did a big project around how can we just be more efficient in our emergency rooms so that people wait 10 minutes instead of an hour and a half when they show up in the ER. I'm sure you've experienced both maybe the bad side and the good side of that. And so they got their emergency rooms working really well. And then the next step, which I thought was brilliant, they started advertising ER wait times on electronic billboards. And the idea wasn't that someone was going to say, oh, look, there's a 10-minute wait time at the HCA emergency room. Maybe I'll go over there now because I need something looked at, because obviously that's not how people decide to go get healthcare.

37:09But what it was is that that person driving by that billboard every day and noticing that the wait time ranges from five to 15 minutes, the next time they do need to go to emergency room, we're going to want to go to that emergency room. There was a long list of, I would think of it more as operating optimizations as opposed to any broad strategic transformation that occurred that really helped drive some incremental growth and some incremental margin expansion and efficiency in the system, which hospital companies are not high growth industries. But if you take a business that probably as an industry is growing low to mid single digit percentages, and you can add a few percentage points of growth on top of that, you can really drive a lot of performance.

37:50And that was really the operating story of what happened with HCA in that era. So when Merrill Lynch had its troubles in the financial crisis, presumably it didn't continue to make these equity investments. Curious if anything happened with their ownership of HCA. You're right. They did stop making these kind of equity investments. They were merged into B of A somewhere along the way. It was still the same actually day-to-day team members that we'd been interacting with all along, but now they were part of what became called BAML, so Bank of America Merrill Lynch. And so in one sense, nothing changed.

38:23But at the same time, the bank itself had some balance sheet considerations and really wanted to figure out where they could generate liquidity to help out with their balance sheet. And so unfortunately for them, they pushed to sell their HCA stake once we were a public company, certainly with the benefit of hindsight, earlier than was optimal. And so we went public sometime in 2011, but they sold their whole stake shortly thereafter. And HCA went on a really nice stock price run basically ever since then. They went public at around$30 a share. And I think the stock is currently somewhere in the mid to high 200s.

39:02And so it's been a really good investment for anyone who bought at the IPO and held onto it. But because of Bank of America Merrill Lynch's balance sheet considerations, it may have been exactly the right decision for them. I don't know what they were dealing with on their balance sheet side, but it did result in them exiting and liquidating their HCA position a lot earlier than the rest of the equity consortium. As you worked your way through the financial crisis, how did you approach the recapitalization and then exit from the business into the public markets? On the recapitalization front, right from 2008, when we started talking about it in the boardroom, we knew that we just needed to have a long-term plan around how we just continue to spread our capital maturities over time.

39:45The next day after you do an LBO, you typically have a debt maturity stack that looks something like all of my debt comes due in years six and seven or something like that, give or take. They vary a little bit. We said, look, as soon as we have opportunities to do so, once the market's healed a little bit, we didn't do very much of it in 2008 or nine, but starting into 10 and 11 and thereafter, let's just start over a long period of time in a very prudent measured way, chipping away at that. And so we started issuing incremental debt offerings out into later maturities, out beyond that six and seven year mark, and using that to refinance our year's six and seven type maturities.

40:24And so in a pretty gradual way, probably over the course of 2010 to 2014 or 15, we really just smoothed off that whole maturity wall. And we refinanced a little bit of it with equity in the IPO, but not very much. The IPO is actually mainly secondary capital because we had done a good job of growing into our capital structure and already going down the path of spreading it over time. And so we got to the point where we had no one year was a big wall of maturity and they were pretty nicely spread out at pretty attractive costs. And so we were helped a lot by the fact that the debt markets did in fact recover pretty strongly after that 2009-10 timeframe.

41:04But I think the thing that the company and the board did that was prudent was just start working on that early and often, as opposed to waiting until we got closer to the maturity. How do you think about your ultimate exit strategy? Well, just given the size of the platform, the base case from the very beginning was this is very likely going to need to be an IPO again. And so now, who knows? There's obviously other things that could happen. We didn't really see any strategic buyer who was going to want to enter the hospital space in this large a way. And at least at the time, there wasn't any set of private equity funds doing transactions as large as this was by the time we got around to exiting it, let alone when we started.

41:44And so it seemed like an IPO was the likely answer. But of course, the question that arises then is, well, it used to be a public company, and at least at the moment we were able to take it private, didn't trade that well in the public markets. And so what's going to be different next time? And so that was actually an important part of what we wanted to do during our pre-IPO ownership period was, how do we build the narrative to help the market understand the strengths that we see in this business so that when we come back to market someday, we'll be aligned in what we're focusing on in terms of the growth opportunities and the strength of the platform.

42:18Part of that is just messaging, but part of that is also just driving the underlying results and being able to show that these investments we've made in our local market presence and the capital that we put in the ground to have the best equipment that it lets us then attract the best physicians that It makes us very high demand from a payer perspective, from an individual patient perspective. Those are the features that really can drive longer-term growth. And so when we did come public again in 2011, that was the storyline and the narrative on our IPO roadshow. And because we also had the results to back up that story, we were able to build a lot of conviction around the public equity buyer base to do a very large IPO.

42:56It was a$4.5 billion IPO. Those are pretty few and far between when you get to IPOs of that kind of scale. And the market believed in that story. And as I said, we went public at$30 a share, which felt like a good valuation to us. But look, I don't think the Frist's have sold many of their shares over the years. And we ended up, I think, selling our last shares around$75 a share or so. So we felt great about our investment. But the Frist family has, like I said, I don't think they've sold a whole lot of shares and they're sitting up probably in that high 200s now. So it's been a really strong, robust performer over time, which is one of the interesting things about taking companies public is the only way that we as a private equity investor can get value from an exit perspective, from an IPO, is by being able to deliver a company to the public market that has a lot of room to keep growing and creating value over time, because we're going to be selling shares for two, three, four, five years, sometimes even longer in some cases.

43:50And there is no greater fool out there. Public investors are smart. If you haven't built a platform that has long-term value creation potential, they're not going to give you a good price for your stock. There's definitely a win-win embedded. And when we've looked at the public equity performance of our Bain Capital IPOs relative to the overall market index, we outperform pretty dramatically. And that's not happening because we're somehow altruistic or we just want to deliver lots and lots of value to public equity markets. It's because that is the only way we can exit, is by taking companies public that actually have a lot of really good value creation runway in them that public market investors can get excited about and therefore want to buy our stock.

44:32So when it was all said and done, what did your returns look like on HCA? We ended up making about a five times multiple of money on that investment. And some of that was value that was created between when we bought the company and when it came public. And some More of that came from the ongoing stock price increase as we exited over time. What were your biggest lessons learned from the deal? For me especially, I was 10 years into my career, but still call it mid-stage in career. And so there was definitely a lot to learn there. I'd say one is it was, especially in healthcare, a really good reminder that the system can change over time.

45:09We owned this company through the Affordable Care Act, and that drove lots of different dynamics, some helpful, some challenging through the healthcare sector. And anytime you own a particular healthcare services business, you can never really predict where the next election is going to go, where the next regulatory initiative is going to go. And so you have to step back and think about, I can't predict all those things. What is it that I feel good about underwriting and standing behind? And in general, it's, is this the right way to be delivering great patient outcomes in a way that is efficient and effective for the overall system?

45:42If that's true, then even if you can't quite predict where all the different regulatory dynamics are going to go or the way pair dynamics are going to go, nothing can go wrong, but you feel like you're probably in a pretty good place in the system. If you find yourself looking at a business that is narrowly premised around some nuanced regulation, and if that regulation changes, your business model is going to blow up, that's a much harder place to be, even if it's a perfectly good business. Another lesson was, in this case in particular, but success in business is not always about some grand transformative initiative.

46:15In some cases, it's just about doing a lot of little things better. And of course, it's critical to have a great management team to be able to do that. But for me, this one feels a lot more like doing a lot of little things better over a long period of time as opposed to some grand transformation. And then the last thing I would mention is just watching and getting to know Tommy Frist and the other members of the leadership team at HCA was a tremendous lesson in the power of culture and how important it is to have a great culture that develops people, makes them want to stay for the long term, and somehow creates both a performance culture and a really supportive, almost family-like environment.

46:54Watching that happen in this company over multiple decades was incredibly powerful and just seeing how important that is and when you can create that, what a just virtuous cycle emerges for business performance. What's the impact of this deal on your career, on Bain and on the industry? For me personally, it was really important. As I said, it kind of came at a time when I was far enough along in my career to probably know enough to learn some lessons from it. And it was a great platform to build out some relationships. And then just being involved with such an important company sitting in hospitals at the center of the healthcare ecosystem as we as all of Bain Capital try to build out our knowledge base and presence in the healthcare space, this was just a really interesting seat to have given how much of healthcare flows through hospitals as it relates to just deepening our experience around the ecosystem.

47:49I think there's always some serendipity in any given career path or any given set of a series of investments one might make. For me personally, this just happened at a really good time to help me build out that experience space at a time in my career when, like I said, I was senior enough to appreciate it, but junior enough still to have tremendous benefit from all those learnings. How about for Bain Capital? It was a high-profile successful transaction that I think was great in a lot of ways. It was a successful investment outcome, but it's also just a great company story. It's a company that has a long history of not just delivering good financial returns, but delivering great patient care and being a really important part of the healthcare delivery ecosystem in lots of different communities.

48:33It's always good to be associated and affiliated with dynamics like that. The relationship that we have with the Frist family and how important that was to all of this happening is always helpful as we talk to other founders out there in the world. Not every transaction we do involves a founder, but certainly a large number of them do. And it's great to have a case study like this to go talk about how this worked and how it happened, and especially how important it is to us that we're trying to be supportive partners to the leaders and managers in our companies. We aren't trying to come in and take control or be incredibly hands-on.

49:09And this was just another really good case study of how this looks and how this can work. And then you asked for the industry also. It's a little harder to say. Certainly at the time, it had some real impacts because it demonstrated you could do a very large debt underwriting. It demonstrated that you could put together an equity consortium big enough to support a very large transaction like this. Those were some very short-term supports. And the GFC happened a few years later and turned a lot of those things on their heads. And so the industry's probably unlearned and relearned a whole bunch of those lessons over the years since then.

49:42How would you apply the experience of going through that to the current market environment? It's one of the things that we talk about with our investors or really anyone who asks is, what are the benefits of having lived through multiple cycles? I started in this business in 97. So we saw the dot-com bubble and the burst there and then lived through the GFC. And then And honestly, one of the more unusual, if you call it a cycle, was the fact that post-GFC, we had 12 years of a lot of different tailwinds going up and to the right, even to the point of heading into a pandemic, as we all experienced in early 2020, and assuming that was going to cause all kinds of dislocation, and then sitting around a year and a half later, being somewhat amazed that didn't happen.

50:26At some level, one of the concerns that people who've been around for a long time had then is there was already this building view that risk was probably being under-discounted just because nothing bad had happened in a long, long time. And even when the bad thing happened, nothing bad happened. And so it was really uncomfortable looking at the risk return profile of some of the transactions that were happening in that 2021 or early 22 timeframe. But at the same time, a lot of investment professionals who'd had a lot of success over time, investing behind some of that upward momentum was interesting tension.

51:00And then now we've obviously had dislocation in the debt markets and dislocation in the equity markets, although business performance is actually for the most part still pretty good. And so one of the lessons of all these cycles and all these crises is that they're very hard to predict in the moment. And we're seeing just yet another version of that now. But specifically, the lessons from this one to now are mainly around how we think about the debt side of the capital structure of our companies. Because you asked earlier about how did you think about post-GFC, that big wall of debt you had maturing out in probably 2012 and 13, and we thought a lot about it early on.

51:38That was a really important lesson for what we look at now, because if you look at the debt capital structures that were put in place in 2020 and 21, they were very aggressive, and for the most part happened with very low interest rates. And certainly, if you look at what would be financeable now on the same transaction on a new basis, it would be probably a lot less debt and it'd be way more expensive on the interest side of things. We're actively engaged in that same long-term planning around our debt capital structures now that we were back in 2008-9 with HCA. An example of that, back in early 21, when no one believed interest rates could ever go up, we actually put in place swaps and hedges to swap out over 95 % of our variable rate interest exposure across our entire portfolio, not because we knew that interest rates were going to go up.

52:26We certainly thought they might as we looked at inflation, but because buying that insurance policy was incredibly cheap at the time because the market was basically pricing interest rates as if they would never rise. And so for very little financial commitment, you could basically cap and swap out all your exposure. So we did that. We've had, in a good way, really no impact across our portfolio from rising interest rates, which has helped our companies be in a good position to have better cash flow and try to grow into any dislocation that we see out there. Chris, I got one more question for you.

52:58What's your favorite aspect of private equity? I would say by far is the fact that it's an investing business where you get to spend a lot of time dealing with real people around different business dynamics. There are lots of different ways you can invest. But a number of them involve a lot of analytics and computer screens and trading. And there's nothing negative about all that. Those are all perfectly good activities. But just for me personally, I find it much more interesting to be in the boardroom, be with the management team, actually work through those dynamics and problems and challenges and opportunities in a very human way.

53:38I've become really good friends over the years with many of the CEOs from companies that we've long exited. And it's, they're not just business relationships, but they've become real personal relationships. Well, Chris, thanks so much for sharing this little history lesson on HCA and the classic success story. It was a lot of fun to do a little walk back through time. I'm always happy to talk about this one. So appreciate you. You have me on here, Ted. This was really enjoyable. Thanks for listening to the show. If you like what you heard, hop on our website at CapitalAllocators.com where you can access past shows, join our mailing list, and sign up for premium content.

54:15Have a good one and see you next time.