The Priory: does it need rehab?

When Jade Goody checked into the Priory a few months back, she joined a long and illustrious list of stars and B-list celebrities who have turned up on the famed Roehampton clinic's doorstep for a few days of much needed rehabilitation.

Her stay there, preceded by the likes of Kate Moss, Noel Gallagher's ex-wife Meg Matthews, and Justin Hawkins, frontman for the Darkness, reinforced the mental health care facility's well-established reputation as the preferred destination for troubled stars.

If only the parent company enjoyed a similarly healthy reputation. Instead, its purchase by ABN Amro and the Dutch bank's stewardship remains one of the most talked-about subjects in the healthcare industry, the object of a rumour mill in overdrive.

To a degree, this is understandable. After all, the boardroom had, until a few months ago, some celebrity intrigue of its own. Since 2000 the company had been run by Chai Patel, the controversial businessman and medical doctor whose £1.5m loan to the Labour party sparked the "cash-for-peerages" scandal. Yet his reign was brought to an abrupt end in March when, with no warning or explanation, he quit. The chief financial officer, David Spruzen, and chief operating officer, Paul Greensmith, followed him out the door. A terse announcement announcing their dramatic departure revealed no further detail, though it is understood that it was due to a falling out between Mr Patel and bankers at ABN Amro. An urgent search for a replacement proved fruitless. "They rang around trying to find a new chief executive, but they couldn't find the right sort of person," said a source close to the situation.

So Hans Michels, an investment banker involved in ABN's £875m purchase of the business in the summer of 2005, was put in place as interim chief executive. He had already served as non-executive chairman of the Priory, but his appointment was supposed to be a temporary fix. Six months on, he is still there.

Much of the equity portion of the original price tag, meanwhile, remains on ABN's balance sheet after it was unable to syndicate it to other investors, according to sources close to the situation. That has led some to question just how long a large, international bank can sensibly keep an acute mental healthcare company on its books. It is understood that the Priory also attempted to flog its property portfolio to British Land earlier this year as part of a sale-and-leaseback plan, but failed. The property move, which would have seen a sharp increase in rents charged to the operating company, is thought to have been a contributing factor to Dr Patel's exit. The Priory runs a network of 42 clinics around the UK.

Complicating the picture even further is the takeover tussle for its owner, ABN Amro. If John Varley or Sir Fred Goodwin, heads of Barclays and Royal Bank of Scotland respectively, end up winning the battle for the Dutch bank, few in the City expect either man to be keen to hold on to a portfolio of mental health clinics. Speculation that Dr Patel, who retains an estimated 16 per cent stake in the company, could be trying to line up a bid with a financial backer to buy the company back – at a steep discount – continues to simmer.

In a rare interview, Mr Michels sought to clear up some of the questions dogging the group. The common assumption that the bank vastly overpaid, he said, is untrue.

"The shareholder [ABN] would disagree. They think it's value for money. If anything, its performance has given a lot of comfort to the shareholder. We will have organic growth in excess of 25 per cent this year. That is a demonstration of the strength of the company."

He also argued that the failure to find a replacement chief executive has not adversely affected the business, and that a massive healthcare company being run by a banker was, in fact, quite normal. "It's not unusual at all," he said. "I can give you many examples in Europe of healthcare companies that are run by former bankers. I would even argue that the majority of CEOs are former financiers, so it's not unusual at all. I have been running the healthcare investment banking business for ABN Amro for five or six years, and I have been chairman for two years as well."

Sources close to the situation said that ABN will find it very difficult to ever get rid of the company without absorbing a loss. It is understood that ABN paid so much more than rival suitors – an estimated £100m more than the next highest bidder – because it viewed it as an infrastructure business, rather than a private equity investment, thereby justifying higher multiples. More than three-quarters of its turnover comes from NHS referrals.

Yet stays for the mentally ill are usually short term, days rather than months. And, until a recent revival, earnings had slowed. "ABN would hate to hear it, but they misunderstood the business. This is a perfect example of why banks shouldn't do private equity style investments," said another source close to the business.

Standard & Poor's, which rates £375m worth of Priory bonds, found earlier this year that "the level of growth has been less than anticipated." The credit rating agency added, though, that it expected business to gain steam by yearend. Part of the group's disappointing growth last year was due to the NHS's massive reorganisation of PCTs, which hampered the day-to-day operation and sourcing of care. That reshuffle is now down.

The Priory pulled in £58m in 2006 earnings before expenses, or Ebitdar. If it picks up by the 25 per cent this year predicted by Mr Michels, Ebitdar for 2007 would rise to about £72m. Even at that level, given the poor state of the global debt markets and industry-standard pricing multiples, getting anywhere near the £875m that ABN shelled out two years ago is still a long way off. Said one banker: "There aren't going to be any mad bankers out there willing to give 9 and 10 times Ebitdar."

Suspicions subsist, meanwhile, that Dr Patel could be readying a fresh bid. "Chai would love to go back into it, but there hasn't been anybody who could sell it," said a banker. Dr Patel was unavailable to comment for this story. Mr Michels said that the two men speak "often" and regard each other with "mutual respect." Dr Patel has never approached him about buying the business back, he added.

The assumption that ABN is desperate to get rid of it is thus unfounded, Mr Michels said. Rather, it seems that, for the foreseeable future, the Priory will remain an operating subsidiary of ABN Amro. "The strategy is for a five- to seven-year period, and it's only two years now, so the investor hasn't any intention of selling the asset at all. They are very happy to be shareholder of Priory," Mr Michels said.

Despite such protestations, it nonetheless appears to be an awkward situation for the bank. "All I can say is what I see from where I stand here," Mr Michels said. "I am proud of this company. I would stand up every day to say that this is the best healthcare company in the UK."

If nothing else, he surely has a chorus of celebrities who agree.