Should private equity play a bigger role in New York State healthcare facilities? This is the question facing New York State legislators for the second year in a row.

Historically, investor-owned corporations have been essentially prohibited from owning and operating healthcare facilities in the state. Governor Cuomo’s proposed 2014-2015 budget and associated legislation would authorize a two-year private equity pilot program.[1]

Under the Governor’s proposal, up to five for-profit corporations, subject to approval by the Public Health and Health Planning Council, would be able to participate in the pilot. Eligible corporations are ones affiliated with an academic medical center or teaching hospital, although the extent of required affiliation is to be determined by the Commissioner of Health. Publicly traded entities and private corporations with more than thirty-five stockholders would be prohibited from participating.

Ultimately, the pilot seeks to support a restructuring of healthcare delivery systems by allowing for increased capital investment in facilities. It is also a response to the troubling fiscal environment hospitals and other healthcare facilities are facing in New York: According to the Healthcare Association of New York State (HANYS), the average operating margin for New York hospitals is 0.89 percent. Since 2000, thirty-five hospitals have closed and the pace of closure is accelerating.[2]

While it will not be the state’s first venture into expanded private ownership of healthcare facilities—an exception was granted, in recent years, to certain centers for dialysis services—authorization for the new pilot is far from guaranteed. A similar program appearing in the 2013-2014 budget legislation proposal was steadfastly rejected by some legislators, particularly in the Assembly, and dropped from the final budget plan. That pilot would have allowed for ownership of up to two hospitals by up to two for-profit corporations (private or publicly traded).[3]

This year, the Senate has once again included a private equity pilot in its one-house budget bill. The Senate proposal moves beyond the Governor’s proposal and expands the number of corporations that may participate in the program from five to ten, as well as increasing the demonstration time frame from two-years to five-years. The Assembly has once again excised the pilot program from its version of the bill.

Is it possible that changes from last year’s legislative approach, such as the exclusion of publicly traded entities, will garner greater acceptance from New York lawmakers? Last year’s effort foundered after a prominent Manhattan Assemblyman opposed the program, aligning with the position taken by the New York nurses’ union on the prior pilot proposal.  This new legislative proposal follows another year of continued problems for New York hospitals.

How will private equity firms react to this potential opportunity?  This clearly is an opportunity for distressed situation healthcare investors to apply the lessons we have seen put into good effect in other states recently – redesign care systems, apply financial discipline, improve hospital performance metrics and start building toward value-based reimbursement incentives that healthcare reform embraces.

For private equity funds considering this investment opportunity who have not been healthcare services industry investors previously, the general uncertainty of investment during healthcare reform is heightened by the New York political considerations surrounding this private equity pilot program.  This is a very limited pilot program, and the terms and potential exit opportunities remain unclear at this time. Can a private equity fund have enough certainty of sufficient return being generated to fund a buy-back to occur in a reasonable investment timeframe?  Will the pilot program rules allow a sale by a participating private equity fund to a subsequent for-profit investor?  Also, will the pilot program be subject to lawsuits due to only allowing investors that are not public companies or broadly-owned private companies – what is the difference from a legal point of view between a publicly traded hospital company and a private equity fund as an investor?  A dollar of investment is a dollar, after all, and it may be difficult to argue that private equity funds are inherently better stewards or operators than some of the publicly traded or larger privately held hospital companies.

Given the size of the New York healthcare market and its high barriers to entry to date, these developments are well worth watching closely.

Eric Klein will be speaking on this topic on April 10, 2014 in New York at the Crain’s Healthcare Conference – “The Money Challenge for New York Hospitals.”

[1] §§ 12-14 of the Health and Mental Hygiene chapter relate to the private equity pilot. The full Health and Mental Hygiene text is available here.

[2] HANYS testimony before a Joint Legislative Hearing on the 2014-2015 Budget (and the source of these figures) is available here.

[3]For coverage on the 2013-2014 pilot and politics, the New York Times has a good article.