It seemed like a good idea at the time – it probably was. That being said, even the strongest companies can struggle under the weight of inflexible covenants. Loading up on debt to finance a strategic acquisition, even in the name of expansion, can lead to difficulties down the road.
That was certainly the case for Harden Healthcare prior to Kohlberg Kravis Roberts’ 2010 acquisition of the mezzanine portion of its capital structure. The firm had only recently added a special situations team to its public markets arm when Harden approached KKR to assist in its refinancing.
Harden specialises in the care elderly of patients require after they are discharged from hospital. With the enactment of the Affordable Care Act (aka Obamacare), however, many firms and financiers were less than eager to back a company that relied on federally-supported Medicare and Medicaid payments for its revenue. The new healthcare regime places a greater emphasis on quality of care as opposed to simply providing payment for services rendered. As such, many worried that companies whose revenue streams depended on those payments will suffer.
In Harden’s case, those worries were coupled with a less than favourable balance sheet, which had been heavily geared ever since the company’s 2007 acquisition of Girling Health Care. “It was a really good business that just happened to have a not-so-good capital structure,” says KKR’s co-head of special situations Nat Zilkha.
“We felt like we had a fundamentally good company, one that we could have a positive impact on operationally, one we felt like we could really understand using insights from other companies that we owned and finally one where we had a fundamentally different view than the market. That allowed us to be a provider of capital where others may not have been willing and therefore less competitive and better pricing,” Zilkha adds.
KKR assumed control of Harden’s balance sheet in March 2010 through a transaction that fundamentally altered the company’s capital structure. It proved to be an essential first step in the company’s development. Although Harden performed well through the economic downturn, the company faced some rather unwieldy covenants through its previous syndication that hampered its growth.
“They had made an acquisition in 2007 and they had gone out to a syndicate that included a junior second lien piece of capital from a hedge fund,” says Zilkha. “That hedge fund had essentially, post-crisis, shut down its lending business, so it had no relationship orientation.”
“It was kind of an orphaned asset.”
Although the hedge fund had been helpful in Harden’s 2007 acquisition of Girling Health Care, it was not amenable to further expansion, says Harden chief executive officer Lew Little. In order to account for the expected declines in Medicare/Medicaid payments, Harden would need to expand volumes through organic growth or strategic acquisitions. Unfortunately, the hedge fund didn’t see it that way.
“They were very happy just sitting and staying where they were, but we wanted to grow the business and take advantage of a fragmented marketplace,” says Little. “KKR helped us do that by coming in and providing us the flexibility that we needed to grow.”
Harden’s chief financial officer – Scott Ellyson – had an existing relationship with Zilkha when Nat was at Goldman Sachs, says Little. Using that relationship as an entry point, Harden approached KKR with the hope of finding a way to work through its capital structure issues and expand.
For its part, KKR was impressed with the company’s underlying fundamentals.
“The company had actually performed well through the crisis, but it had very aggressive covenant step downs built into its covenant agreements. It was starting to run up against those covenants and the company was seeing really interesting opportunities to grow through acquisition,” says Zilkha, adding that the restrictive nature of those covenants were prohibitive to expansion. “They really didn’t have a capital partner in the hedge fund who was willing to engage with them. They were being very aggressive with them, relative to the potential covenant issues, and they wanted someone who could step in and solve that problem.”
To help Harden configure a new capital structure, KKR brought its capital markets team to lead a $235 million refinancing. The firm syndicated the revolver and senior portions whilst holding the $90 million mezzanine portion through its special situations fund, Zilkha says.
“Rather than have them try to negotiate with all those individual bank lenders, we provided a one stop shop. They had one partner who was able to commit to their entire capital structure.”
Harden wasted no time working the capital structure. In August 2010, the company acquired Voyager HospiceCare from Apax Partners in a $90 million deal that expanded the company into three new markets – California, Alabama and Colorado – along with the addition of 58 new hospice facilities.
KKR provided $50 million of new junior securities, which took the form of debt and equity, to finance the acquisition, Zilkha says. The remaining $40 million was placed or syndicated by the firm’s capital markets team.
In this instance, Zilkha’s connections to a broad network of private equity professionals working in the healthcare sector benefitted Harden’s expansion. Zilkha’s connections to Apax’s healthcare team helped facilitate the transaction.
“Buddy Gumina, who’s a partner at Apax, is someone I’ve known for many, many years. And I think that relationship was very constructive when it came [to] hammering out a deal that worked for people on both sides.”
That acquisition, along with a handful of smaller deals, allowed the company to expand its footprint and pick up revenues through patient volume that had been lost to declining Medicare/Medicaid payments, Zilkha says. The improvement in volumes were amplified by the involvement of KKR Capstone, the firm’s operations team, which improved the quality of Harden’s sales force and helped optimise its IT platform.
The final step for any investment, of course, is the exit. After three years spent guiding the company through its balance sheet issues and subsequent expansion, KKR sold its stake in Harden when the company was acquired by Gentiva Health Services for $400 million. The firm’s funds generated a return of approximately 2x on the deal, a source with knowledge of the deal tells Private Debt Investor (Zilkha did not discuss terms of the transaction).
Remarkably, the returns weren’t generated through an auction process. KKR and Harden had maintained a running dialogue with many companies in the post-acute care industry throughout the span of the investment, Zilkha says. As the company reached a point where it felt merging into larger entity would be the right move, Little believed existing relationship with Gentiva provided a strong fit for Harden’s future.
“I found [Gentiva] to be very similar to us in terms of values, personality and culture,” says Little. “We provide them, I think, a really excellent entrée into the personal care business, which I think is going to be a key component of the post-acute continuum going forward.”
Three years removed from the paralysis of unfriendly covenants, forward seems the right direction.