Chris and Rob Michalik - Twin Tackle of Private Equity at Kinderhook (EP.416)

Chris and Rob Michalik are twin brothers and co-founders of Kinderhook Industries, a middle-market private equity firm overseeing $8 billion focused on healthcare services, environmental services, and the automotive aftermarket. Chris and Rob joined me on Private Equity Deals to discuss one of their portfolio companies, Ironclad Environmental Services, and that conversation is replayed in the feed. This time around, we discuss their story attached at the hip. We cover their background and path to starting Kinderhook, including rooming together for the first 26 years of their lives. We discuss the firm's family-like culture, three pillars of its investment approach, unwarranted scrutiny of private equity in the healthcare sector, and the recent example of their purchase of Stewardship Medical Group out of the bankrupt Steward Healthcare. Take Capital Allocators Audience Engagement Survey https://www.capitalallocators.com/annual-survey/ Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup

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• 0:01Ted Seides?

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• 3:32Ted Seides?

  Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at capitalallocators.com.

• 3:59Speaker 01

  All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.

• 4:18Ted Seides?

  My guests on today's show are Chris and Rob Michalik, twin brothers and co-founders of Kinderhook Industries, a middle-market private equity firm overseeing $8 billion focused on healthcare services, environmental services, and the automotive aftermarket. Chris and Rob joined me on private equity deals to discuss one of their portfolio companies, Ironclad Environmental Services, and that conversation is replayed in the feed. This time around, we discuss their story attached at the hip. We cover their background and path to starting Kinderhook, including rooming together for the first 26 years of their lives. We discuss the firm's family-like culture, three pillars of its investment approach,

• 5:01Ted Seides?

  unwarranted scrutiny of private equity in the healthcare sector, and the recent example of their purchase of Stewardship Medical Group out of the bankrupt Steward Healthcare. Before we get going, there's a silver lining or icing on the cake on last week's elections, depending on your political perspective. That is the potential of what our last two guests will do for the country. Brad Breiner won his race for Treasurer of the State of North Carolina. He mentioned on the show that he'll be hiring senior investment seats as soon as he takes office, and we'll be there to help Brad do everything we can to turn around the worst-performing state pension fund in the United States.

• 5:43Ted Seides?

  So stay tuned for job opportunities in the near future. And Scott Besant may find himself with a senior economic role in the new administration. He'd make a fantastic Treasury Secretary, and I'm optimistic the President will choose him for the role. Now, I'm not going to say that Brad's appearance on the show caused his victory at the polls, and I'm definitely not going to say that sharing Scott's wisdom and the potential plan to serve swayed voters in the presidential election. But I'm not not going to say that old capital allocators boost is back either. Either way, we're excited to see the impact Brad and Scott may have in the coming years. Thanks so much for spreading the word.

• 6:27Ted Seides?

  Please enjoy my conversation with Chris and Rob Michalik.

• 6:33Speaker 02

  Rob, Chris, great to see you guys. Thank you, Ted. Appreciate it. Thank you for having us back on your show. We're really honored to do it. Why don't we go back to, I guess we could go back to the womb, but let's just go back to growing up together. Chris and I grew up west side of Detroit. My dad was a fireman. Mom worked at Wayne State, both union employees. And Chris and I started in business together, other than shoveling snow and cutting grass, had a paper route. Detroit News, our first acquisition. Routes were bought and sold in the early eighties. And it's just really interesting. We spent four, five years with this route. We had over a hundred customers. It was 15 cents a day, 50 cents on Sundays, so a dollar 40 a week.

• 7:15Speaker 02

  I think you got 25 cents out of that dollar 40 for the paper boy, plus your tip. So we're bringing home $40 a week to share, divide that by the hours worked, I guess was just above minimum wage. It was an interesting experience for us. You really actually learn a bit about business in retrospect and things about customer acquisition and service collections. You get stretched by a customer. At some point, they go, how do I owe you for four weeks? So you have to stay on top of them. As we got through high school, then we became truck drivers. So my brother and I actually joined the Teamsters Union right out of high school, got our class one truck drivers licenses and started driving delivery routes for Coca-Cola in Detroit. Another fantastic experience.

• 7:58Speaker 02

  And then when we got to New Haven, drove for Star Distributors in Fairfield County. My brother drove for Carolina Freight Carriers. And again, you're interacting with customers on the street at local levels and really wonderful experiences that have carried on with us. What's interesting about it is the experience that kids don't get today. Everybody wants an internship today, the private equity firm or an investment bank. And I would call it the school of the real world. I think there's nothing better, be it working as a waitress or a waiter in a restaurant or working in a service business or working in a hospital and dealing with the real issues that make a business run and understanding how people treat the people that make the businesses run. Because ultimately, when you start as an analyst or an intern at a bank, that's wonderful.

• 8:42Speaker 02

  But it doesn't really teach you much about what makes the real world tick. It makes you work hard, but not necessarily understand people. And I think when you roll forward to your career, understanding people and working with people is the things that help make you successful. So outside of being attached to the hip in these

• 8:57Ted Seides?

  Jobs. What were you guys like growing up together?

• 9:00Speaker 02

  Very much your stereotypical identical twins. Left-handed, I'm right-handed. We are mere twins. You do become a bit of the sideshow and our friends had great fun asking us to switch classes. Can you go take your brother's test? Okay, no one ever really knew. Switch on the girls. Okay, sure. That's fun for you guys. You do become pretty tight. Rob and I, we shared a bedroom for 19 years. We were roommates for 26 years. So not only did we obviously grow up together, we went to college together, played sports together, and ended up when we moved to the city and took our banking jobs, we were roommates in the city and then roommates when we returned to business school. So we have been 26 years. So the real separation anxiety occurred when we were adults.

• 9:44Speaker 02

  Maybe it never sank in. Now we live about eight miles apart and our kids pretty much grew up going to the same school. It's a unique thing. I think it's a real asset. It's something that we appreciate, that our firm and our team appreciates. There's pros and cons, but one of the things that we talk about a lot is consistency. Despite the fights, we're brothers like any other brothers. We fight. The stability and the foundational core values of what we're trying to achieve, those things don't change. And I think it's been very helpful to us over the course of our careers. Our grandmother, when we were born, looked at us and said to our mother, they're so cute. It's a shame they have to share a brain.

• 10:23Speaker 02

  It's the collective judgment experiences that we can bring to bear. It's mutual respect, it's communication, it's trust, it's transparency and sharing information, ideas. And when you put all that together as brothers, twins, families or firms, you get better outcomes.

• 10:42Ted Seides?

  What was your respective paths from those initial jobs to finding your way into what Kinderhook's become?

• 10:49Speaker 02

  Started my first job out of college with Morgan Stanley in the mergers and acquisitions group. This was the early 90s and worked awfully long hours on lots of transactions. I think what woke me up to private equity, we had pagers back in that day. And the assignments associates would page you to call them to get an assignment when something came up. And one Friday, 6 o'clock, right on time, the pager goes off. Associate walked onto his office, he says, Rob, KKR wants to do a buyout of Quaker Oats. We need you to put together this analysis for comps, DCF, precedent multiples, and we

• 11:32Speaker 02

  need it by Monday morning. Okay, so I spend pretty much the next 60 hours straight in the office finalizing this analysis and no one ever asked for it. What I realized at that moment is that some enterprising young man was on his way to the Hamptons, had a brain fart about taking Quaker Oats private and called Morgan Stanley and I worked all weekend while he was having fun and going to parties and nice dinners. And when he came home on Monday, he probably had some new idea from some interesting conversation he had over the weekend in the Hamptons. And I said, geez, I like to be on that side of the business. I've worked down at Solomon Brothers, down at Seven World Trade and Solomon at

• 12:13Speaker 02

  the early 90s, I was in training when the bond scandal hit and the cadre of senior professionals were forced to leave Solomon Brothers. Warren Buffett stepped in to bail out the firm. We were in a recession, our economy, deal flow is very low. And then at Solomon Brothers, deal flow is even lower because literally when I joined the M and A department as an analyst, when I was in training, we had a legal sheet of the MDs and the deal teams and all the professionals within mergers and acquisitions. And when I got out of training six weeks later, we had a business card and had about six people left. So pretty much everybody would quit or was fired. The beauty of that, probably from a development standpoint, is though I'd worked on one live transaction in two years, I still worked the 80 hours a week like everybody else does because it's part of the indentured servitude of investment

• 12:58Speaker 02

  banking analysts. But you got a lot of reps and you got a lot of exposure to the handful of senior people that actually stayed. It was a really good experience, probably helped get into business school that you're associated with a firm that went through a real transition. But like Rob, you learn a lot about business and I think what was apparent to me is that there's a lot of ways to make money, but if you're a paper boy as an example, or you own something, you get the job done in 10 minutes and you make 20 bucks. Do it in 10 minutes. If you're getting paid by the hour, like we were in our Teamster jobs, hardworking jobs, but the incentives are a little strange. You want to fill the hours or maybe create overtime and do things. It became obvious that making money by being

• 13:40Speaker 02

  an owner was really interesting and having the good fortune to have went out to Yale and be exposed to Wall Street and be exposed to the capital markets. I think there was a great opportunity to find the situation to be an investor. It wasn't obvious when I was 20 or 22, but by the time I was 24 and had that exposure, you start to appreciate that being an owner was a really nice thing. And private equity 25, 30 years ago was not mature. And there's a great runway ahead of us that we were able to take advantage of.

• 14:10Ted Seides?

  So, once you had the idea that you wanted to be involved in owning businesses and private equity, as you're coming out of business school, how did you grow into learning what aspect of private equity you wanted to play?

• 14:21Speaker 02

  Good question. Any aspect was probably my answer. And this comes back to, and lessons learned in retrospect, I spent the better part of my first year at business school trying to get a job, literally sending out resumes. This is before email. So it's not just send an email. This is go to the research library, try to identify companies, find their names, figure out who the people are. And then you had to call them on the telephone. Got a okay summer job when I was in business school, did not get an offer to return. And then spent my entire second year of business school interviewing, not exaggerating, probably had over 100 phone interviews, 50 interviews, graduated from Harvard Business School without a job. And

• 15:01Speaker 02

  ultimately, in the late August of 1995, got a job in real estate private equity with a firm called Colony Capital out in Los Angeles. So, great opportunity, hadn't been to Los Angeles once in my life, said yes, took the job and moved out to Los Angeles to begin my career. So, we asked, what private equity? Any private equity.

• 15:22Speaker 02

  I started in UBS Capital as a group that I met while at Morgan Stanley, interviewed, got a summer internship between first and second year of business school, went back after business school. Very interesting opportunity because you were working with other private equity firms. We had a committed pool of capital from the bank that allowed us to make equity investments alongside multiple private equity shops. It was intended to bring broader business to UBS. So really as a, I would almost say a loss leader to bring leverage loans and advisory and other services that UBS was looking to build at that time. Several of those partners that I worked for decided to leave.

• 16:05Speaker 02

  So I decided to leave and ended up at a firm called Thera Capital Partners in Washington, DC. I was on the ground and I think Chris will have similar experiences from Capital Resource Partners. Going into smaller, new firms like my brother and I did when we started in the investment world really made us entrepreneurial. We were not in environments where it was rote, put together a certain type of model to put together a certain type of presentation for Monday morning committee meetings. We were in environments where it was find an opportunity, get to know people, smile and dial, meet with bankers, meet with managers, meet with anyone and look at opportunities.

• 16:46Speaker 02

  And when transactions occurred, we were really hands on and working on those transactions at a very young age. And it put us in a position to really accelerate our learning, but it also accelerated our networks. My brother and I always thought we were going to work together at some point. Within years of being at Thera, writing a business plan about what we thought we wanted to do in the private equity business. Colony Capital, good firm, nice people. I moved over from Colony because I didn't really want to be in real estate. Once I got my foot in the door, I said, hey, what's the next step up? Capital Resource Partners was a growth mezzanine shop in Boston, spent two years there and then was fortunate to be able to join the Soros organization. The other thing I'd mention in addition to entrepreneurial situations.

• 17:31Speaker 02

  Good mentors. Fred Danforth, a wonderful man, was the owner and founder of Capital Resource Partners. He came over and created what was Soros Private Equity Partners in 1998. Frank was generous to the young people that he brought in to work for him. Had great perspective of the industry that I still think about a lot today. It didn't raise a lot of money, but Frank would always say, make money, have fun. And you look back, Frank let us run. He let us go out as young, early 30s team of professionals, find deals, meet people, deploy capital. He kept reins on us, but he was willing to let capital seek opportunities because ultimately Frank taught us a simple point, which was you can only lose one times your money. And in our business, we're looking to make three to five times your money.

• 18:15Speaker 02

  So if you're afraid to shoot, you're never going to score. So it was a great environment to learn and to build businesses and to get your footing in industries. It's helped create a foundation for our career and good people that then supported us when we left to start our own firms as well.

• 18:32Ted Seides?

  Rob mentioned you always thought you were going to work together. At what point in time did you guys come back to working together?

• 18:38Speaker 02

  The conduit in this was our Harvard Business School suite mate, Tom Tuttle, who's our third founding partner of Kinderhook and has been a great friend for 30 plus years now. Tom was an entrepreneur as well, started a group called Global Emerging Markets. They were a broker advisor, early days of the pipes business. And Tom found a number of small investment opportunities as a result of his business model of looking to find small cap public companies to make private investments in. Some of those public companies had subsidiaries and divisions that ultimately were worthy of acquisition. And Tom called Chris and I and said, hey, guys, I have an opportunity.

• 19:19Speaker 02

  What do I do? You're in private equity. Help me figure out how to buy this business. That was the genesis of Kinderhook. We lent Tom some relationships on the lending side, on the legal advisory side. And Tom pulled together a couple of small transactions in the late 90s. He bought the Fire Troll Aerial Fire Retent business from early industries. Small deal. He passed the hat around his friends and family. Raised $2 million of equity capital to buy that business in 1998. Chris and I collectively put $75,000 into that, which was all the money in the world for us. And it turned out to be a home run.

• 20:01Speaker 02

  Tom had, over the next three, four years, put together four more small transactions. And that ultimately became the basis upon which we launched Kinderhook. Tom had great deal flow, small market value. Chris and I had great executives and personal relationships in industries that we could bring to bear to those types of companies. The key to success in private equity is the executives who build the companies and the partnership between the owners and the executives. And we've prided ourselves on being great partners. And being great partners has led us to many acquisition opportunities, many referrals from the executives. We partnered, our operating partner network is full of executives

• 20:43Speaker 02

  who we have now built and sold multiple companies with at Kinderhook. That's the genesis of how we started our firm.

• 20:50Ted Seides?

  So some of the basics there, the name Kinderhook, where'd that come from?

• 20:54Speaker 02

  Kinderhook, that's a softball. Our partner, Tom, grew up in Kinderhook, New York. Kinderhook is famous for a couple of reasons. One, the legend of Sleepy Hollow, Washington Irving happens to be buried on Tuttle's family farm in Kinderhook, New York. And then our eighth president of the United States, Martin Van Buren. He hated Washington DC. So you have to go up to Kinderhook to get him to sign off on legislation. And he would sign it, Martin Van Buren, okay for old Kinderhook. And the punchline is that when he had his presidential campaign, his campaign slogan was, "You're okay with Van Buren." That's Kinderhook's history. And we did choose industries over partners or capital, working with people, working with executives.

• 21:36Speaker 02

  We did not want to be just another private equity firm with our name on the door. It wasn't named Tom, Robin, Chris Capital, or Tuttle, Michalik and Michalik. So we went with Kinderhook Industries.

• 21:46Ted Seides?

  Then as you brought your experiences together, what did you crystallize as your strategy at Kinderhook?

• 21:51Speaker 02

  So when we raised the first fund, it was really buy value, back great managers and grow. When the great financial recession hit in 2008, a lot of companies went through some very hard times. We had a portfolio of companies that also had some bumps in the road. We have never been big users of financial leverage. Our strategy has been to give our executive teams the flexibility to grow and invest. So as a result, you leveraged at three times, you lose half of your EBITDA, you're at six times and you can survive. If you leveraged at six times and you lose half your EBITDA, you're at 12 and you're bankrupt. So we started taking advantage of those over leveraged situations to strengthen our portfolio and came through the great financial recession with some very strong companies.

• 22:35Speaker 02

  And that led to a focus on consolidations. But just as importantly, we learned that you really needed to be experts in industries to be able to add value and create value in a private equity portfolio. And so we quickly honed in on where we had the most experience, the deepest bench of executives in relationships and focus on three core industry groups. And that's healthcare services where Chris leads the effort, automotive, aftermarket and light manufacturing, where Tom leads the effort, and then environmental and industrial services, which is what I do.

• 23:10Ted Seides?

  So if you break each of those down, the concept of buying value, how do you go about, in a very competitive market, trying to find opportunities where you can buy things cheaply?

• 23:20Speaker 02

  We definitely want to buy value, but I would say it's more about buying good platforms and as Rob continues to reiterate, invest in people. So we always say that we invest in people, not in companies. And we don't buy companies that we don't believe we have a strong executive to lead and utilize our operating partner. When you think about private equity broadly, and it's a very competitive market, there's now tens of thousands of private equity firms in the United States. And everybody does, just like we talk about investment banking or anything else, the same thing. It's about the team, the general partner. Who's the team? How do they build that team? It's about deal flow. How do you find deals, opportunities? To invest in, it's ever more competitive. And that's about operating partners and every firm has operating partners and operating partner strategy.

• 24:02Speaker 02

  And Kinderhook's success from our vantage point is that it's how you operate in those three legs of the stool and how you be very successful with each of those legs of the stool and it's intentional. So our team, a lot of great things about our team. The thing I think we're most proud of is that our team has been built from within. So everybody that's a managing director today has been with the firm and started as an associate and has been promoted internally. We don't bring in lateral hires. Over 21 years that we've been in business, anyone that's made vice president or above has never quit the firm. We have a wonderful culture, but we also have a culture, how we compensate our team, how to develop our team. We're sharing the wealth with our team. So very important part of our strategy, creating consistency.

• 24:43Speaker 02

  When we talk about the three segments in deal flow, deal flow, again, 20 plus years ago, and we started small deals. You could hustle and find different things, but deal flow comes from being an industry expert. When you think about buying value, value is in the eye of the beholder. So it's really about knowledge that gives you the ability to buy value. Some of the companies that we've bought in healthcare services space, we own medical card systems. It's a Puerto Rican Medicare Advantage HMO. Most everyone in the United States in the industry looked at buying this company from private equity firms to United Healthcare, to Molina, Humana, and they all passed. And we bought the business in 2021. We actually signed a letter of intent to acquire it in the fall of 2020 during COVID.

• 25:27Speaker 02

  Because we saw value that other people didn't. We believe that we could step in, buy that company, create value and grow. And then the last leg of that stool is operating partners. And operating partners is the most important of those three legs. Because ultimately they're the people that drive the value. They're the people that create the company's success, drive the growth. Private equity is a governance structure. We're not a public company board or a family owned business or not for profit. Our value is bringing governance, alignment of interests and incentives for their management teams to grow. So value is about the combination of those things. And then ultimately driving growth in the business and creating companies that are strategically interesting, that you can sell to strategic buyers.

• 26:08Ted Seides?

  When you want to back management teams, how do you go about the assessment?

• 26:12Speaker 02

  75, 70% of the time when we buy a company, we're putting in one of our operating partners as the CEO. The other 25, 30% were back in the incumbent management team. We will put our existing operating partners onto the board. We want to make sure there's that continuity and that training and that stability. And one of the great successes that we have had is that we have been able to keep our operating partners with us over multiple deals, multiple companies, multiple funds. Over the course of our 20 years and eight funds that we've been doing this, we started inviting our operating partners who had some success to invest in our fund. If you look, the last two funds, operating partners invested $100 million. They're paying full fees, full carry. They believe in what we do and they love being a part of our organization.

• 26:57Speaker 02

  So this is a real strategic asset and I think a real difference maker in how we drive success.

• 27:03Ted Seides?

  When you look through that last lens of helping grow the businesses, what is it that you do that's different from other private equity firms?

• 27:10Speaker 02

  Rob will say all the time, it's unleashing the American dream for a lot of these people. This comes back to the focus on growth, low leverage going in. We meet with and talk to the teams on where they want to go and what the opportunities are. And then we ensure that they're capitalized to execute on those opportunities. A lot of it is consolidation-led growth, specifically in the environmental and industrial services arenas that I invest in. In the healthcare services side, it's new locations, new facilities, new offices and new teams. So there's a J-curve effect of investing in those types of facilities and growing those markets. But it's the orientation toward growth and driving returns through growth as opposed to financial engineering.

• 27:52Speaker 02

  And the families that built companies that get to a point in a stage where they know they could grow, they know they could maybe buy a competitor, but they don't want to take that risk on their own balance sheet. We become great partners for them to allow them to recap their business, put money in the bank, secure the trust in the family and retirement, and take risk again to build and grow their businesses. So that's really been the model of success for us.

• 28:19Ted Seides?

  What do you think works in making investment decisions when you clearly have a partnership from birth that's not going away anytime soon?

• 28:27Speaker 02

  Ultimately, you keep. Can't blame the other person. One, things don't go well. And at Kinderhook, I believe, one of the biggest reasons we've been successful and had the stability of our team, we've done bad deals. We're not immune from bad deals. It's because we have done the bad deal, i.e. the firm, and it's our responsibility to fix it. If there's a pattern of laziness, a pattern of lack of concern, a pattern of just poor decision-making over years, we have fired some people over the 20 years that we've been doing this. But from a culture of accountability, hey, we're accountable for the deals. And when the investment committee, which is Tom, Rob and Chris, but it's the firm, because we all have ownership, we all have carry, we make that investment, we own it.

• 29:09Speaker 02

  And it's our job to make sure we have the best outcome, we grow the business. And I think that mentality of shared responsibility, shared accountability, that Rob and I, that's our life. Like it or not, judge it or not, people look at us as one, it's the circus show. So I think those are some of the strengths that come from the circus.

• 29:31Ted Seides?

  We're going to take a quick break in the action to tell you about Brookfield. Brookfield invests in the thing behind the thing behind the next big thing. Their focus across infrastructure, energy, real estate, private equity and credit is helping to build the backbone of the global economy. Brookfield combines deep operational expertise with disciplined, long-term investing, uncovering value and partnering alongside clients to shape tomorrow's economy today. Invest in the businesses that shape tomorrow. Learn how you can own what's next at Brookfield.com/own.

• 30:08Speaker 03

  This is not an offer to sell or investment advice. Investing involves risk, including the loss of capital.

• 30:14Ted Seides?

  And now, back to the show.

• 30:18Ted Seides?

  So I'd love to dive into one of the examples of the businesses. And I know, Chris, there's a lot of buzz, not positive buzz, about the healthcare sector and private equity. And before we jump into this recent interesting example, I'd love to just get your impression of all this noise.

• 30:35Speaker 02

  I appreciate you asking the question. It's unfortunate, but our healthcare system in our country is a very complicated one. And I've been investing in healthcare for over 25 years now. I made some early investments in hospice care in 1998. It was introduced to government pay. As you look at what's happened over the last 30 years, over 55 to 60% of all healthcare in the United States is paid for by federal and state programs. That's a result of both demographics and the fact that politicians will continue to support healthcare in our country and lead to drug development. So that's the first overlay. I think you have to understand what has happened as part of that is that you've had consolidation. And because the margins are very low in healthcare services, I think people forget

• 31:19Speaker 02

  that hospitals don't make a lot of money. They've never made a lot of money. HMOs don't make a lot of money. They've never made a lot of money. Doctors used to make a lot of money. In the seventies and eighties, the doctor was the pillar of the community. He had the nicest house, had the nicest car, went to the country club. Today, doctors work very hard and make more of a middle income salary. And the burden on them to deliver healthcare has increased exponentially because of the paperwork, because of the bureaucracy, because of the cost, and because of the fact that many of them now step out of school with very high debt. So there's all these factors that go into healthcare in the United States that are very complicated, and it's not a great system today.

• 32:01Speaker 02

  So despite the fact that even after the passage of the Affordable Care Act, most people have access to health insurance, it does not mean that they have access to healthcare. It's become popular to look for someone to blame. And unfortunately, I think that blame has went an easy target is private equity because they want to look to someone and maybe say, oh, they're rich, their incentives aren't aligned with the delivery of good healthcare. That's a much maligned perspective. I'm never going to say there's no bad actors, but by and large, 99% of private equity professionals in healthcare are looking to invest in businesses, grow those businesses, provide opportunity to the caregivers and the patients so they have broader access to healthcare.

• 32:44Speaker 02

  What we do in healthcare service investing is look at either commercial payer government programs and say, how do we participate in these programs to create efficiency and to drive growth such that there's more access for patients? If you just take providers, over the last three or four years, there's been a rapid consolidation of primary care, as well as especially providers of healthcare services. And it's been done by private equity. But it wasn't led by private equity. People forget that the big buyer of providers is health systems. The health systems have consolidated. Hospitals are mostly not-for-profits, but they need to put people in beds. Their asset is a bed. They get reimbursed to have people in that bed. They're like a hotel or an airplane.

• 33:29Speaker 02

  If they're empty, no money's coming in, that's not very good for their business. So to make sure that they can control the volume of patients, they try to buy providers. A lot of providers don't like to be managed. Doctors don't want to be managed by anyone. They have a mission and a purpose, which is to care for patients. In their perfect world, I think doctors are saying, I don't want to be owned by a hospital system. I don't want to be owned by a HMO, a health maintenance organization, and I don't want to be owned by private equity. I want to be either an individual operator or a partner with my fellow doctors. Unfortunately, the dynamics in the market have changed, and that's very hard to do today. One, as I stated, doctors come out of school with very high debt load in almost all cases.

• 34:11Speaker 02

  They then spend four years in a residency and then specialty training, where they make really no money. It's indentured servitude. They come out and they need to get a job, and they can't hang a shingle and put on a lease because they're structurally bankrupt the day they walk out of medical school. Number two is the burden to provide care is not just about seeing a patient. After I'm done doing that, I need to now put all that into a system. And government mandated electroic medical records from patient files a long time ago. These systems still don't talk to each other in most cases. Long story short, that doctor is burdened by paperwork. The cost of their rent's going up, the cost of their staff is going up. Now they need to collect money to have it be paid for. And in a few markets, people pay for healthcare with cash, but in most markets, you collect from insurance.

• 34:54Speaker 02

  As much as the we as individuals want to complain about insurance not paying, doctors complain more about insurance than patients because you have a runny nose and you come in and see your doctor and you think that doctor visit is $120, but that doctor is being reimbursed $20 by United Healthcare to tell you you have a runny nose. The doctor can't make a living doing that. So he or she needs to scale their business and put in back office billing people. So now imagine as an individual operator, that's not realistic. So now they have to be part of a group or part of a system. And that's where private equity comes in. When a doctor sells to a hospital system, an HMO, or to private equity, they're in a free market system, they're doing what they think is in their best interest to manage the best for their patients.

• 35:39Speaker 02

  And they are focused on patient care. What we do, and our private equity brethren as well, is that we provide these doctors now an opportunity to do what they've been trained and desire to do, deliver high quality healthcare by bringing in infrastructure, software support, EMR billing, systems, leverage and collections with contracting, bringing in contracts. If you think about the big three forces of healthcare, these HMOs negotiating to keep rates down and provide access. Hospitals are negotiating to bring in as many patients as they can and get the highest prices they can to cover their fixed costs in their own minds. And then doctors who are the delivery of care, who are the weakest member in that three person negotiation.

• 36:22Speaker 02

  And we help the doctors, we get better contracting with United or with the hospital system, which provides more access, lower cost and better healthcare. So no system is perfect. Everyone behaves according to their incentives. I could spend a long time talking about the poor incentives that are created by our healthcare system, mostly created by government programs. But ultimately, private equity is part of the solution and we help invest in and bring additional resources to communities, to low income neighborhoods and the like.

• 36:55Ted Seides?

  As you describe that value chain, the system's not great. Each of these three important buckets aren't making a lot of money. How do you think strategically about where you can invest so that you can make attractive returns in a system that is fairly unwieldy?

• 37:12Speaker 02

  The market of today is really around providers because it gets back to there aren't enough doctors to service all the patients that now have access to healthcare. So introducing technology to help scale what a doctor can do by freeing up their time to focus on patients as opposed to paperwork is part of what leverages cost, as well as what people call mid-levels. So nurse practitioners, PAs, physician assistants, people that are not trained to hold a medical degree, but have training to deliver basic healthcare needs and can serve patients so that doctors can stratify their delivery of healthcare by hiring mid-levels and they can see the sickest patients in triage. And bringing those resources and scaling doctors is a great opportunity.

• 37:57Speaker 02

  And that's something that you see smart practices and private equity, that innovation, understanding how to work with the payers to make that billable, et cetera, is all very important. People want healthcare, but they don't know anything about that has to be paid for. And the billing system and the payment system is a big part of it. Another big area of investment is in revenue cycle management and the collection system around healthcare.

• 38:19Ted Seides?

  I'd love to dive in a little bit on your most recent acquisition, which has been one of the more colorful names in the headlines, Stuart. So why don't you walk me through this opportunity and how it came to pass?

• 38:31Speaker 02

  Stuart Healthcare was a company acquired by a private equity firm in 2010 or 12 called Cerberus. They acquired a group of struggling hospitals and through a series of acquisitions over a 10 or 12-year period, built up a multi-state hospital, private for-profit hospital company. And while they were doing that, like many health systems, they also acquired the providers in those communities as part of their ownership. So they had both a hospital system, Florida, Arizona, Western PA, Massachusetts being the biggest, where they had hospitals in a network. Work of providers. Over the course of the last several years, Cerberus sold the business through a leverage recap.

• 39:11Speaker 02

  And that leverage on the businesses with a lack of reimbursement ultimately led the business to file for bankruptcy. But in December of 23, Stewart, prior to bankruptcy, looked to sell their provider group. So they took all of their providers, put them under a basket of ownership called Stewartship within Stewart and tried to sell it. We looked at that opportunity. We bid to acquire those assets. United Healthcare ultimately agreed to acquire those assets for $850 million. And in May, Stewart filed for bankruptcy. Everyone thought that United was going to proceed with the acquisition of the Stewartship hospitals at this $850 million. And right around Memorial Day, it began to leak through the system that maybe United wasn't going to be there.

• 39:55Speaker 02

  We got called back in early June of 2024. If we were still interested in acquiring the provider group out of Stewartship, we said yes. We see it as a great opportunity. These are primary care doctors in low income communities, serving patients. And it's an opportunity where we can continue to do the things I said in terms of investing in technology, investing in mid levels, helping these doctors extend their careers, bring them capital to recruit new providers into their practices. So a lot of opportunity to stabilize the system and grow it. Ultimately, we ended up being the only bidder. So much to our surprise. And I think we were the only bidder for one reason. There's a lot of negativity and the things associated with private equity owning healthcare right now.

• 40:39Speaker 02

  The centers from the state of Massachusetts have been vocal that private equity should not own healthcare. And I think a lot of people just shied away from the opportunity. We leaned in. We think that this is the right thing to do. This is the right set of doctors. We have the right leadership. So we signed a purchase agreement in August of 2024 to acquire the assets of Stewartship. Publicly announced $245 million. So a much reduced price from what at least at one point, United seemed interested in paying and will have a great group of people and providers that are going to serve the communities that they're in. It's been announced that Massachusetts. On August 31st, they closed two hospitals. Those communities are going to have less access to healthcare. Maintaining their providers in those communities can be very important.

• 41:24Speaker 02

  And having a network of providers that continues to exist there. So that's what we're excited about. We were surprised to be the only bidder. There's been noise recently since we bought it that maybe private equity is not the best buyer. Kindred is not the best buyer. I think that's unfortunate. It lacks substance and fact, but it is something that we believe will overcome. And we're very confident that our management team and the providers that we've met with and spent a lot of time are highly supportive of us coming in and helping them. We've had near universal support from the over 300 employed providers in the state of Massachusetts that they want rural health groups slash Kindred to be the acquirer of these assets. So we feel very good about where we are.

• 42:05Ted Seides?

  How do you think about underwriting the risk that you have all of this noise, particularly in Massachusetts, its core market? That someone along the way changes regulations to make the business much less attractive than you think it would otherwise be?

• 42:20Speaker 02

  That's a great question, Ted. And government programs, healthcare stroke of pen risk, as it's called, is something that people are very concerned about and have been concerned about. We've had success building companies in hospice, in home health, in government Medicaid and Medicare HMOs. We've been in the clinical research space. Clinical research, as you might imagine, if you think about it, most new drug development is paid for obviously by drug companies. But those drug companies are supported by the high demand for new pharmacies that are paid for by government programs. So our whole ecosystem in healthcare is really driven by government demand and government intervention. If you're going to be a participant in healthcare services, I would say you have to be comfortable with that risk. And it comes back to delivering high quality care.

• 43:05Speaker 02

  The stroke of pen risk or the noise, I think it's interesting, Gavin Newsom recently vetoed legislation in the state of California to put further oversight into the acquisition of healthcare investments in the state of California. So the pendulum swings, it swings back and forth, but ultimately patient satisfaction.

• 43:25Speaker 02

  Success by delivering high quality businesses, I think, is what will stem this pendulum, which I think is swung in a very negative direction right now to come back to a center where you see people confident in the ability to grow value, deliver service to members in the support of these government programs. At the end of the day, it may sound cynical, but politicians are there to serve their voters and voters aren't going to be happy when they don't have access to healthcare.

• 43:50Ted Seides?

  What's your game plan with the business and taking it where you've bought it and seeing how you can improve it from here?

• 43:56Speaker 02

  This has been a very under invested in group of providers. So these providers, because of the financial constraints that Stuart had, did not hire new staff. They haven't done anything to improve the environments that their physicians are working in. So the first thing we're going to do is invest into the business, infrastructure, signage, reception rooms, medical product. So we'll restash the closets for Band-Aids, so to speak, because in the primary care, it's shocking where these businesses have come to. We will be bringing in new technologies to help electronic medical records, share records amongst the providers and amongst the health systems that service the patients and the specialists that service the patients to create efficiency. We'll invest in mid levels, capital to bring in people and

• 44:41Speaker 02

  staff and look to open new clinics. Ultimately, growing populations, you want to have new clinic growth and expand service. We will do it in the markets that we currently serve. We have enough footprint in Massachusetts is the biggest, South Texas, Arizona, and Florida, the four largest markets that Stuart had. We'll stay in those markets and grow density in those markets. And ultimately, look, we are private equity, part of what private equity does. We buy businesses, we build, improve and grow those businesses and we sell them. We're passing the baton to the next buyer. We believe when we invest in and grow this asset, there'll be many interested buyers, including hospital systems, HMOs, maybe this company's of scale, it could have

• 45:22Speaker 02

  public market access at some point, but our job is to buy, improve, grow and sell. And that's what we'll be looking to do with the asset.

• 45:29Ted Seides?

  How do you think about the return on investment in those investments you'll be making in the business when it's already a low-margin business?

• 45:37Speaker 02

  That's a great question. Where the leverage in the business comes from is from scale. So where the incremental margin is what's known as full-risk contracts, this value-based care, people have heard this term floated around. The reason that value-based care works, it's because it provides alignment between the patient and the provider. So that's the purpose of value-based care. It's something that the government has talked about, accountable care organizations, that's a government incentive program to create patient-provided alignment. MIPS was another one. DCE was another one. There's multiple programs over the last 15 years that the federal government CMS has implemented to create patient-provided alignment. Very few of them have succeeded. Value-based care

• 46:22Speaker 02

  is the effort really of the market to do exactly that. And the reason it makes sense is because ultimately, as a provider, by taking risk, you put yourself in the position, and think about primary care, where you're trying to make sure that the patient is taking care of themselves before there's a billable event. So sharing in the savings of that cost is what value-based care is. It creates an economic alignment between the patient's health and cost containment that allows providers, doctors, to make more money. And those shared savings go across the network that allow us to invest in the growth of the networks. And the more those networks grow, the more power they have in negotiating provider rates with the payers.

• 47:04Ted Seides?

  How do you think about what success looks like in this investment?

• 47:08Speaker 02

  Well, success here will be, one, improves quality scores. So we will drive up the KITA score, star scores across our network. That will be tangible and it'll be seen. It's one of the metrics. These are the state, local, federal government standards where they measure quality. And our goal is always starts with quality. Two will be patient population growth, so census growth for our providers. If we can get their census from taking care of, I'm just making up numbers, 100 patients to 150 patients on their patient panel, that means we have broader reach and Broader access to the community and then growing those providers because ultimately, again, it's a free market. Providers choose. Providers that are with us, they can quit. They can go across the street and if you're in Massachusetts and go work for Beth Israel

• 47:51Speaker 02

  or Mass General, they don't have to work for stewardship. They choose to work with stewardship because of being good partners. So that network in the last 18 months has shrunk. People have left and chose to leave stewardship because of the leadership, bankruptcy, whatever. Our success will be growing that network and having people be choosing our business going forward. So those will be the metrics of success and it'll be tangible in patient experience, provider satisfaction, and ultimately the financial success of the business.

• 48:23Ted Seides?

  I want to ask you guys a couple of closing questions. Before I dive into that, I'm really curious, what you think are the most important lessons you've learned from either coaches in your football days or mentors along the way?

• 48:35Speaker 02

  In retrospect, as a parent and as a coach, what I learned is that parents who care, coaches who care, get better outcomes from their players, from their children. So being private equity investors who care, being a manager of a firm who cares about its employees, we ultimately get better outcomes from our team, from our executives. It's almost human nature. I never thought about it when I was a child. I never thought about it when I was a player, but I sit here today, the fact that my coaches cared about me, made me feel compelled to want to do better for them. The fact that my mom and dad cared about me, made me want to do better by them and make them proud. So that, like I said,

• 49:19Speaker 02

  I believe it's human nature, but I think it gets lost. I would say the beauty of team sports is that you have to play your responsibility and you're accountable for your individual contribution to the team. And if you carry your water and trust the other people, getting that word trust, then you're going to have success. And it gets back to you can't blame. So when you're an offensive lineman, you go to the line, you got to make your block. If you don't make your block, you have the lookout block, somebody gets hurt behind you. But it requires everyone to be Coordinate it and move as a unit and there's going to be weaknesses and failures. And if you go back to the huddle and you start fighting, you're not going to succeed. And if you go back to the huddle and say, we got this and we work together, you're a servant to your teammates.

• 50:03Speaker 02

  That's what leads to success. And I think that's what I learned being a player and in particular a football player is that you are there for the team. And when you're there for the team, the team succeeds.

• 50:13Ted Seides?

  As you guys look at your business and all the changing dynamics in the private equity industry, curious how you look out over the next couple of years and what you want to do both strategically and to continue the success of Kinderhook.

• 50:27Speaker 02

  If you're not growing, you're dying. So we need to continue to grow our firm. We need to continue to grow our fund size. We need to continue to invest in our people, our infrastructure. We continue to develop our young talent. So creating opportunity for the team, when people don't feel like they have opportunity, they go elsewhere. And there's been a lot of investment into this team and organization. So that's probably the most important thing. Because of the talent that we've been able to foster within our firm over the last several years, I think we have the opportunity to continue to spread our wings. We did a lot of environmental services. We now do industrial services and that's become very powerful additional within that vertical. But it could be a vertical in and of itself and our industrial services business has been very successful.

• 51:12Speaker 02

  We continue to develop our organization in these areas of expertise and it helps us leverage our operating partners. I think the other thing is, quote, old guys, look, for all of our operating partners that have been with us for 20 years, just like building our own team, we need to bring in new, young, talented operating partners. We're doing that, but it's very important. If you want to continue to deliver value, you have to have CEOs in waiting, so to speak, people that you trust to step in and lead the businesses you buy.

• 51:38Ted Seides?

  All right, guys, I want to make sure I get a chance to ask you a couple of closing questions so we can go with both of you. Hopefully it won't be the exact same answer. We'll see. What is your favorite hobby or activity outside of work and family? Chris, why don't you go ahead?

• 51:49Speaker 02

  I love to fish and fishing is fun. It takes talent. It's a little bit mysterious. You don't really know what you're going to pull up. You don't know if you're going to be successful. You don't know what factors affect your success. Is it weather? Is it me? Is it the bait? So do a fair amount of fishing, both fly fishing, saltwater and freshwater and offshore fishing as well. But really enjoy the fly fishing and casting for fish. Trolling for fish can be fun, but it's really more fun to actually fish and be out there and it gives you time away. You're on a river, you're out in a boat, you're away from your phone, you're away from a big group of people. So it's a real change from what we're doing or I'm doing every day. Same answer.

• 52:27Ted Seides?

  All right, Rob, let's try this one. What's one fact that most people don't know about you?

• 52:32Speaker 02

  That my exciting accent is actually a speech impediment. There's no such thing as a Detroit accent. That's called being born second. I kicked him on the way out.

• 52:41Ted Seides?

  All right, Chris, what's your biggest pet peeve?

• 52:44Speaker 02

  Probably when my brother tells me I'm wrong.

• 52:46Ted Seides?

  Rob?

• 52:47Speaker 02

  Same answer.

• 52:50Speaker 02

  What I actually had in mind is laziness. The least you can do is make an effort.

• 52:55Ted Seides?

  All right, Rob, which two people have had the biggest impact on your professional life? I have a feeling I might know who one of them is.

• 53:02Speaker 02

  I could say a lot of people, but obviously it's my brother. And then it's my wife because my wife let me work with my brother. So.

• 53:11Ted Seides?

  Chris?

• 53:12Speaker 02

  That's a good answer. Thinking about people outside of the family, a gentleman named Jeffrey Keenan has been a mentor to Rob and I. Rob worked for him back at UBS 30 years ago. And Jeffrey's been a consistent voice of reason and someone that has clarity of thought and has been willing to do things for us professionally, step into operating roles, step into all kinds of situations to be helpful. So Jeffrey's truly been a great business mentor. And the other person, our partner, Tom, it's a unique person to say they want to be partners with identical twins. And we all have strengths and weaknesses, but Tom had the vision, the courage. Tom said, hey, I want to be partners with these two guys.

• 53:57Speaker 02

  And that's led to our collective success amongst the three of us. So Tom's been a great partner and someone who has a lot of foresight and character to be able to manage what, as you can see, is a pretty complicated situation.

• 54:11Ted Seides?

  What's the best advice you've ever received?

• 54:14Speaker 02

  We went to Catholic high school and it always set up on the side of the gym. God's gift to you is who you are. Your gift to God is what you make of yourself. And it's somewhat cliched, but ultimately you're responsible for yourself. We all face adversity. We don't achieve the things we want. But ultimately, if you have a positive attitude and you continue to think, what am I trying to achieve? You can be successful and persevere. And so I think that just having that in the back of your mind and say, hey, what can I do to be more successful? I think it's just there that we have to think about that all the time.

• 54:44Ted Seides?

  Rob?

• 54:45Speaker 02

  Our high school football coach was a great communicator and he would come up with expressions and themes. And one of the themes I always remember is there's magic in believing. And it's one of those, you gotta believe in yourself. You gotta believe in the people around you. You gotta have faith. And I think it's been a great lesson.

• 55:06Ted Seides?

  All right, guys, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

• 55:12Speaker 02

  We were very fortunate to start Kinderhook when we were relatively young. We were 33, 34 years old when we decided to try our hand at starting our own firm. And I think in hindsight, fortunate because life moves fast. If you're going to bet on yourself, bet on yourself. And I think about young people today and it seems like adolescence extends later and later and later in life, but you're not young forever. So I encourage young people to believe in themselves and bet on themselves. I think it's a great thing.

• 55:47Ted Seides?

  All right, guys. Thanks so much for sharing this very connected experience you guys have had together.

• 55:53Speaker 02

  Thank you, Ted. Really appreciate it. Thanks, Ted.

• 55:57Ted Seides?

  Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com where you can join our mailing list, access past shows, learn about our gatherings and sign up for premium content, including podcast transcripts, my investment portfolio and a lot more. Have a good one and see you next time.