ABN AMRO?s surprise acquisition.

Although the Priory is best known as a detox for celebrities, it gets most of its revenues from the NHS. It generates £120m a year through its 40 centres and 1,700 beds across the UK, which includes schools for children with learning difficulties.

ABN AMRO paid £875m for the business from private equity firm Doughty Hanson, which acquired it in 2002 from Westminster Healthcare and made an equity return of 4.9 times. Mike Nawas, global head of fixed income capital markets at ABN AMRO, says there are several reasons why it was the bank’s capital markets division making the acquisition rather than the private equity arm ABN AMRO Capital. One was that ABN AMRO Capital focuses on deals worth between €50m and €500m, much smaller than the Priory transaction. Also, the private equity division has a portfolio approach to its acquisitions rather than the deal-by-deal approach of the investment bank.

Nawas says: “I think there is a blurring of boundaries between private equity and the banks, with banks not only arranging finance but also acting as partner or, in this case, sole underwriter.” He added this was not the first such acquisition by the bank, which bought Belgian bank Credibe two years ago as an investment rather than to integrate into ABN AMRO.

The Priory Group was in a sector that the bank believed would produce high growth and where there were high barriers to entry. “If you have a good reputation like the Priory you can produce fairly good, stable earnings growth going forward, given certain expansion plans. It fits very well with our return requirements.”

The bank is looking to hold on to the company for around five years, but will first seek to refinance the acquisition so that it holds less than 50% of the Priory and thus can deconsolidate it from the bank’s balance sheet. “We will be raising debt on a non-recourse basis during this year and simultaneously, or immediately afterwards, we’ll be looking for others to invest in the equity,” said Nawas.

Some in the market were extremely surprised at what the bank was willing to pay. According to some sources, the other bidders were in the £700m to £800m range, considerably below the £875m paid by ABN AMRO. “It seems that Mike Nawas was happy for a massively high debt multiple based on his confidence in the management team,” said one observer close to the deal. The same observer added that Nawas seemed to have based his debt multiples on 2006 “run rate” EBITDA, which were considerably higher than the 2005 figure because they factored in new extensions to existing businesses at the Priory. Another factor in Nawas’s valuation is thought to be a McKinsey programme being implemented at the company, which aims to increase referrals by developing better relationships with referring GPs and to cut costs by reducing overstaffing.

Nawas confirmed he was extremely confident in the management, led by chief executive Dr Chai Patel, and that they had been given strong financial incentives to grow returns. Chai Patel has said he was delighted ABN AMRO won the deal because they have a longer-term approach and less ambitious targets on returns than a private equity owner.

Nawas dismissed the claims that ABN AMRO bid far above the competition: “The difference between the bidders in the second round was small. When you get a lot of bidders with specialist market knowledge you’re not going to get that much difference between the final bids.” According to Nawas, the capital markets team can bring more flexibility to the deal than a private equity house in areas such as capital expenditure. “We can give management more flexibility because we don’t rely on equity returns only to meet our return expectations,” he said.

The bank has also told the management team it would be prepared to consider raising more debt to do future acquisitions. But Nawas would not comment on whether the Priory would be interested in a £100m autistic schools business currently on the market being sold by Deloitte and which, according to analysts, would be a natural fit with Priory.

According to Nawas, ABN AMRO is looking at the deal not only from the perspective of an equity investment but also as a return on total invested capital because of the multiple

cross-selling that is possible. He

said: “We are providing a debt and equity package, a derivatives package and so on. We’ve more products to offer than a private equity house and that needs to be included in the calculation. The idea of a one-stop shop for these products also appeals to management.”

The Priory’s main asset is property, valued at more than £300m. Dr Victor Chua, partner at consultants Candesic, which advised one of the other bidders, said: “The business is eminently leverageable and asset-backed, which makes aggressive financing possible, and it has clearly the strongest management team in the business.”

He added that ABN AMRO won because all the other bidders were relying on financing from separate institutions, while ABN AMRO did all financing and due diligence in-house, and because they were comfortable with the management’s very aggressive revenue and profitability forecasts. “Of the Priory Group’s four core business segments, three will continue to experience strong private and public demand and there is limited supply growth near Priory sites, so most Priory businesses should continue to experience good pricing and occupancy,” he said.