A grand jury in West Palm Beach this year exposed the shameful operation of Florida Institute for Girls, a prison for maximum-risk and mentally ill teens. The causes of FIG's many problems are debatable. Indisputable is the damage to girls who were molested by men working for Premier Behavioral Solutions, a private company hired by the state to run FIG. Two Premier staffers were convicted of felonies. One had had sex in a bathroom with two different girls on the same day.
Found in default by the state for persistent failures at FIG, Premier stopped running it in May, two years and $11 million short of its contract. It still must defend itself against the American Civil Liberties Union, which is suing Premier to make public its FIG records. It also plans soon to quit running a boys' prison, which it decided is not adequately funded. All in all, a mess -- yet not one that investors in Premier's parent, Nashville-based Psychiatric Solutions (PSYS ), would know about. Psychiatric, whose stock is up 189% in a year and is pushed by Wall Street as a hot grower, has disclosed none of Premier's troubles in Securities & Exchange Commission filings. This is true even though it filed its latest annual and quarterly reports weeks after it agreed in February to quit FIG.
PSYCHIATRIC EXECS SAID FIG is a unique situation, one the company is moving beyond. They said Psychiatric is proud of its work in Florida, where as the biggest operator of juvenile prisons it has won a commendable rating. They also noted that its Florida juvenile prison contracts, acquired in a 2003 merger, make up a small part of total revenue. That slice is narrowing as the company snaps up private psychiatric hospitals, its main strategic goal. This year, the number of beds it owns or leases leaped past 4,000 from 2,800. From $294 million in 2003, revenue this year may top $490 million, so Psychiatric sees its reverses in Florida as too minor to disclose. "We report our 10-Q in compliance with SEC regulations," CEO Joey Jacobs said.
Yet it's easy to imagine that investors may be in for a shock. First, there are the ACLU suits. If the ACLU prevails, claims for damages by parents of girls who were mistreated at FIG will follow, predicts Frank Kreidler, the Lake Worth (Fla.) attorney pressing the suits. Psychiatric's treasurer, Brent Turner, said it has plenty of liability insurance. But its 10-K warns that punitive damages may not be covered. Second, while Psychiatric's first-quarter revenue jumped 190%, to $108 million, revenue excluding acquisitions rose 3%. Psychiatric has told the Street it expects revenue longer-term to grow at "strong single-digit" rates. Its loss of $15 million in annual revenue from FIG and now the boys' prison won't help. Premier has 10 more Florida contracts worth $23 million a year, expiring at various points through 2008. Its overall performance -- successes, plus what happened at FIG -- will weigh on the contract renewals, said the Florida Dept. of Juvenile Justice.
If, as Psychiatric hopes, its expansion by acquisition pays off via stronger demand for behavioral health care, higher prices, and efficiencies, then FIG will be a blip. Yet Psychiatric also is a heavy user of debt. In eight deals over 12 months, it paid some $205 million, mostly on credit. Investors might want to recall Magellan Health Services (MGLN ), a behavioral health company that recently exited bankruptcy after rapid growth. I asked Magellan's CFO, Mark Demilio, what went wrong. "We increased the debt to do acquisitions," he said. Will Psychiatric necessarily follow suit? "We have ample liquidity to continue to execute" our expansion plans, says Psychiatric's Turner. Should investors reassess the risks the company faces? Not to would be foolish.