Envision Disaster Deep Dive
Welcome to the forty-third Pari Passu newsletter.
Today, we are going to learn more about one of the most electric Chapter 11 and Liability Management Exercises (LMEs) of these years: Envision, a KKR-backed company. Buckle up.
Envision Deep-Dive
In 2018, Envision Healthcare was purchased by KKR for $10B using a mix of $6.5B in debt and $3.5B in cash equity. The company’s post-LBO 7.5x leverage multiple was publicly justified using its “light maintenance CapEx” and “significant free cash flow” [1].
Five years later, the company filed for Ch. 11 bankruptcy.
Despite Envision’s best efforts, which culminated in a series of increasingly hostile Liability Management Exercises (LMEs), KKR’s invested equity will almost certainly be zeroed while ownership of the company is transferred to creditors.
This raises the question: what led it astray? What caused KKR’s largest ever equity investment to go to zero? To answer this, we must first understand Envision’s role within the American healthcare system.
Chapter 1: Background
Envision is a physician staffing company that partners with hospitals and health systems to provide patients with surgical care. It also offers ambulatory services through its subsidiary—AmSurg—with which it merged in a 2016 all-stock transaction. See below for relevant definitions [2] [3]:
In-network: when a doctor, hospital, or care provider accepts your insurance. This means the care provider has agreed to accept your insurance’s approved price for their services.
Out-of-network: when a doctor, hospital, or care provider does not accept your insurance. This means you, as the patient, need to pay the difference between the provider’s full charge and your insurance’s approved price.
Surgery center: freestanding facilities that provide same-day surgical care (i.e., surgeries that do not require an overnight stay at a hospital)
Surgery hospital: exactly what you think of when you think of a hospital
Ambulatory centers: similar to surgery centers with the main difference being ownership. Surgery centers are generally owned and run by hospitals (subjecting them to the hospital system’s rules and regulations) while ambulatory centers are independently owned and operated.
Both surgery and ambulatory centers provide outpatient procedures (i.e., surgeries completed in a few hours) and are generally performed outside hospitals. Ambulatory centers are a particularly appealing option for patients due to the quality of their service, significantly lower cost, and increased convenience. In fact, ambulatory surgery centers comprise nearly two-thirds of the outpatient market [4].
With this in mind, let’s examine Envision’s business model.
Business Model
Envision’s physician staffing segment functions by contracting with hospitals to staff them with an array of medical professionals that primarily cater to emergency care rooms. The company earns revenue from the services performed by its doctors through disbursements from the government and private insurance. Anything left after deducting compensation and miscellaneous costs (e.g., malpractice insurance) becomes profit for Envision [5].
The key to this segment is its primary area of focus: emergency care rooms. By focusing on emergency rooms, Envision was able to exploit loopholes in the healthcare system and leverage its inherent pricing power to charge patients above market rates for the medical services performed by its doctors.
Pre-LBO, the company’s medical professionals remained out-of-network for many insurance companies. This meant that patients who traveled to a hospital in their network would be charged out-of-network prices for any surgeries performed by an Envision doctor. Patients facing unexpectedly large bills inevitably complained to their employers, who then pushed insurers to accept the charges levied by Envision. Or, in a practice known as balance billing, Envision would directly pursue patients to make them pay the difference between the out-of-network charge and their insurance’s disbursement.
These aggressive business practices caused the company and its peers to face significant public backlash (along with the threat of congressional legislation), ultimately resulting in Envision’s late-2018 decision to go in-network with major insurance providers. However, the company was able to continue charging above market prices by leveraging the ever-present threat of going back out of network.
Separately, Envision’s AmSurg unit owns and operates a number of ambulatory surgery centers (ASCs). ASCs earn incremental revenue through increases in the number of patients served, and primarily perform elective surgeries. The main costs for this business are labor and equipment costs.
Corporate History: LBO to LME
At the time of its LBO, Envision and its peers seemed unstoppable as physician staffing companies were able to generate significant recurring cash flows by charging above-market rates. This is what made them an attractive buyout target, as it seemed irrational to think they would be unable to service the debt placed on them. However, this mindset rapidly shifted with the onset of the COVID-19 pandemic.
The pandemic caused Envision to face the first of many hurdles. While COVID led to an initial spike in emergency visits, the company lost 65% to 70% of its non-emergency medicine patients. This resulted in a 2020 loss of ~$1.1B in revenue along with a $415M reduction in EBITDA. In fact, Envision was only able to survive the pandemic through a combination of CARES Act funding, fully drawing its $300M revolver and a distressed exchange [6].
COVID also led to a nationwide shortage of qualified healthcare professionals and a significant increase in labor costs. Compared to 2019, Envision paid an additional ~$330M annually on doctor compensation in the aftermath of the pandemic [7].
Complicating matters further, Congress had moved against Envision. The 2020 No Surprises Act, and the Biden administration’s corresponding regulations, banned the practice of balance billing effective January 2022 [8]. This significantly knee-capped the impact behind Envision’s implicit threat to go out-of-network if its above market rates were not reimbursed, as such rates would no longer be legally tenable under the new legislation.
The No Surprises Act also greatly empowered insurance companies to deny what they believed to be unfair or egregious charges, as was demonstrated by Envision’s largest payor—UnitedHealthcare (UHC). In early 2021, UHC dropped Envision from its network and began aggressively denying the company’s commercial claims; increasing its denials from 18% of submitted claims (pre-removal) to 48% of all submitted claims (post-removal) [9] [10]. According to Envision, UHC’s actions resulted in ~$50M in denied payments per year starting in 2021 and a $200M deficit in the claims they chose to pay.
Ultimately, the ramifications of COVID and the No Surprises Act combined with Envision’s unsustainable leverage / interest expense to starve the company of oxygen. To remedy the situation, Envision tapped PJT and Kirkland & Ellis in late 2021 to advise the company on how best to de-lever / bring in critical liquidity. It is from this arrangement that Envision’s infamous LMEs were born.
Chapter 2: Demolition Derby
Before continuing the story, we must first understand the twin concepts of uptiers and dropdowns (skip to Phase 1 if you already have a good grasp on these).
Uptiers
Uptier transactions allow a majority (50% + 1) of secured creditors to prime non-majority secured creditors by giving themselves “super-priority” liens on a loan’s underlying collateral. These transactions are contingent on two key factors:
Whether credit docs allow for a simple majority to amend lien subordination provisions
Whether the debtor is allowed to execute non-pro rata debt-for-debt exchanges
Majority creditors give themselves super-priority liens by amending credit docs to create new tranches of debt above any existing term loans. These creditors then exchange their old debt, at a discount, for new debt within the super-priority tranche (while also contributing new money to the debtor). With this said, how is this allowed? Doesn’t the priming of minority secured creditors violate pro-rata sharing provisions within credit docs (i.e., provisions stating that any term loan pay down must be done equally amongst all term loan holders)? This is where the two necessary factors for an uptier transaction come into play.
For non-pro rata subordination, the devil is in the details. If credit docs allow for a simple majority to amend subordination provisions, or rather, if they don’t require unanimous consent to amend said provisions, then the creation of super-priority tranches can be done easily. The tricky part is how to justify the debt-for-debt exchanges, as these are only done with a select group of creditors. The key to these exchanges is found within the language surrounding a debtor’s allowed open market purchases (of their own debt). If credit docs allow debtors to conduct cashless transactions (e.g., debt-for-debt exchanges) as a part of their open market purchases, then majority creditors can bypass pro-rata sharing provisions as these purchases, by definition, are done with some creditors and not others [9].
Dropdowns