The Health Care M&A Monthly: A Midsummer’s Hospital Market
After a drought in Hospital M&A activity during July, August recouped with a spurt of deals. In the past four weeks, eight transactions have been announced involving 47 acute-care facilities with a combined total of 8,205 beds. By comparison, during the first six months of 2004, a total of 48 hospitals with 7,404 beds were acquired in 24 deals.
Based on prices revealed so far, a total of $3.6 billion has been committed to acquire the 47 hospitals in August. This amount compares favorably with the $2.4 billion spent on hospital M&A in the entire first half of the year.
Although we have been predicting a bounce in deal volume due to Tenet Healthcare’s (NYSE: THC) divestment program—and we did indeed see some Tenet sales this month—the lion’s share of activity comes from two big deals involving for-profit operators.
--Blackstone Recapitalizes Vanguard Health
The Blackstone Group, a private equity firm, announced early in the month that it is taking part in a $1.75 billion recapitalization of the hospital operator, Vanguard Health Systems, in return for a 66% equity interest in the recapitalized company.
With offices in New York, Boston and Europe, The Blackstone Group has raised $32 billion for alternative asset investing since its formation in 1985; $14 billion of that amount has been for private equity investing. Blackstone has been casting about for additional health care opportunities, considering several different sectors, including Home Health (see p. 13), but finally settled on the Hospital sector.
Formed in 1997 and based in Nashville, Tennessee, Vanguard Health Systems is a privately held operator of 16 acute care hospitals with 3,784 beds and other, related health care facilities. Vanguard’s facilities are located mainly in urban or suburban markets: Chicago, Illinois; Phoenix, Arizona; Orange County, California; and, most recently, San Antonio, Texas. Somewhat unusually for a hospital operator, also included among Vanguard’s assets are two insurance products. Phoenix Health Plan is a Medicaid managed care plan serving 96,000 members in Arizona while MacNeal Health Providers serves 48,000 capitated lives in metropolitan Chicago. Vanguard generates annualized revenue of approximately $1.7 billion, EBITDA of $170 million and net income of $36 million. As for sources of revenue, managed care (including Medicare and Medicaid managed care plans) accounts for 45.8% of patient service revenue, Medicare for 30.4% and Medicaid for 6.9%.
Under terms of the deal, Blackstone will invest $500 million in the equity of Vanguard; management will reinvest $114 million; Morgan Stanley Capital Partners, Vanguard’s original investor, will reinvest $130 million; and another shareholder will reinvest $5 million. The total equity in the recapitalized company is thus $749 million. As a result of the recapitalization, Blackstone would hold 66% of the equity, management and Morgan Stanley would hold 30% and the remainder would be held by other shareholders.
Further, Vanguard is restructuring its debt, which effectively raises the total transaction value to $1.75 billion. As a step in this direction, Vanguard has already undertaken a tender offer of its $300 million aggregate principal amount of certain senior subordinated notes.
Thus, the price-to-revenue (P/R) multiple in this deal is 1.01x, the price-to-EBITDA (P/EBITDA) multiple is 10.1x and the price per bed is nearly $462,500.
This deal should allow Vanguard to make new capital investments in its existing markets and pursue selective acquisitions. Vanguard’s growth has been slow, accumulating 16 hospitals in six years. Before this deal was announced, Vanguard had already rolled out a program to spend up to $370 million over the next four years on its hospitals in Phoenix and San Antonio.
The deal at hand will allow it to spend money on its remaining hospitals in the other markets. Vanguard will most likely seek to shore up market share in urban markets where it has serious competition, like Chicago, by undertaking capital projects or by making acquisitions. Such bulking up could also be in anticipation of an eventual IPO.
While the P/EBITDA multiple seems a little high, investors are bullish about the financial prospects of Vanguard’s recent acquisitions. Still, the company’s EBIT margin is currently around 10%, while that of many publicly traded hospital companies is in the high teens, so some extra effort will be required at those facilities not performing as robustly.
--LifePoint Buys Province Healthcare
News of the second major hospital deal came in mid-August as LifePoint Hospitals (NASDAQ: LPNT) announced it was acquiring Province Healthcare Co. (NYSE: PRV) for approximately $1.7 billion in cash, stock and assumed debt.
LifePoint Hospitals was formed in 1997 as a division of HCA (NYSE: HCA)—then Columbia/HCA—and subsequently spun off from its parent in 1999 at the same time Triad Hospitals (NYSE: TRI) was. LifePoint’s rationale was to operate sole community providers in rural markets, a niche that competitors Community Health Systems (NYSE: CYH) and Health Management Associates (NYSE: HMA) have found so rewarding.
LifePoint currently operates 30 hospitals in nine states with a combined total of 2,793 beds. The nine states are Kentucky (8 hospitals), Tennessee (7), Alabama (4), Florida (2), Louisiana (2), Utah (2), West Virginia (2), Wyoming (2) and Kansas (1). Note that half of its hospitals are concentrated in just two states: Kentucky and Tennessee. On a trailing 12-month basis, LifePoint generated revenue of $967.6 million, EBITDA of $188.4 million and net income of $78.1 million.
Founded in 1996, Province also specializes in rural markets with sole community providers: it operates 20 hospitals in 12 states with 2,486 beds. It is present in Louisiana (4 hospitals), Texas (3), California (2), Indiana (2), New Mexico (2), Alabama (1), Arizona (1), Colorado (1), Mississippi (1), Nevada (1), Pennsylvania (1) and Virginia (1).
PRV’s operations also included Brim Healthcare, a hospital management subsidiary, but a month before the current deal was announced, PRV sold Brim off for $13.2 million. In 2003 Brim contributed revenue of $15.8 million to PRV, so this sale should not have a significant impact on continuing operations. On a trailing 12-month basis, Province generated revenue of $818 million, EBITDA of $120 million and net income of $59 million.
Under terms of the deal, Province shareholders are to receive $22.75—half in cash and half in LPNT stock—for each share of PRV common they hold. Thus, each PRV share is to be exchanged for $11.375 in cash and $11.375 in LPNT stock. An exchange ratio of between 0.3447 and 0.2917 is to be applied, as long as LPNT’s average share price is between $33.00 and $39.00.
LifePoint will thus pay out approximately $1.13 billion in cash and stock. The company will also assume about $570 million in PRV debt, which raises the total purchase price to $1.7 billion.
The acquisition multiples are among the richest in recent memory: the P/R multiple is 2.1x, the P/EBITDA multiple is 14.2x and the price per bed is a princely $683,830.
The combined company would operate 50 hospitals in 19 states with about 5,280 beds: all but three of those facilities are sole community hospital providers. As a result of this exchange, PRV shareholders will own between 27% and 31% of the combined company.
In return for relinquishing majority control, this deal offers PRV shareholders a 66% premium over the closing price of the stock on the day before the announcement. News of this deal sent LPNT stock down 19% while PRV shares shot up 39%, eating into that premium. But do the rationales offered for the merger support such a hefty acquisition premium and multiples?
First, LPNT management claims that the merger will result in synergistic savings of between $15 million and $18 million. Of that amount, between $5 million and $6 million would result from savings in executive salaries and benefits; $4 million to $5 million from savings in duplicative positions and $3.2 million from savings in retirement plans. So much for operational efficiencies.
Second, and on the plus side, the combined company’s risk would be spread over a wider base. At present, 73% of PRV’s revenue comes from its 10 largest hospitals while LPNT’s 10 largest facilities supply 55% of its revenue. After the companies combine, only 44% of revenue will come from the 10 largest hospitals.
Third, the combined company would have greater bulk, placing it closer to CYH and HMA, its most obvious competitors. As may be seen in the chart on page 3, the combined company would rank fifth in terms of acute care hospitals owned and seventh in terms of revenue.
Behind these reasons may lurk some degree of sibling rivalry. From one perspective, it looks like LPNT is playing catchup with sibling Triad Hospital. Triad was spun off from HCA with 31 owned hospitals at the same time as LPNT was, but made its big move in 2001 when it acquired Quorum Health Group for $2.4 billion (at 1.36x P/R and 7.9x P/EBITDA). With a variety of divestments and acquisitions, TRI now owns 49 hospitals.
Finally, recent changes to Medicare rules will raise reimbursement to rural acute care providers next year by 6.2%, as compared with the average hospital, which will receive a 5.7% increase.
Still, the question remains: Are these reasons sufficient to justify the high price paid? We may not know until two or three years after the deal closes, scheduled for early 2005, and the effects of the consolidation on the financial statements shake out.
Citgroup Global Markets, Inc. acted as financial advisor to LPNT while Dewey Ballantine LLP served as legal advisor. Citigroup has committed to arrange $1.725 billion in a senior secured credit facility. Merrill Lynch served as financial advisor to PRV while Alston & Bird LLP acted as legal advisor.
In both of these big deals, the remaining managers will have their hands full trying to squeeze better margins out of operations and better returns for investors.
--Tenet Keeps Shedding Hospitals
Tenet Healthcare divested a total of five hospitals this month in two separate deals. In the first one, it is selling four properties in the Los Angeles market with a combined total of 609 beds. The buyer, based in LA, is AHMC, Inc. which operates Alhambra Hospital Medical Center and Doctor’s Hospital Medical Center in Montclair.
AHMC is paying $100 million, or $164,200, for the four facilities, enlarging its area network. AHMC has committed to offer employment to substantially all employees and to honor any labor agreements, suggesting that initially there may be little consolidation at the facilities.
In a separate action, Tenet has also returned control of 232-bed Doctors Medical Center in San Pueblo, California to the West Contra Health Care District from whom it had been leasing the facility. No money changed hands.
The second deal involves a hospital that was not among those Tenet announced it would divest in January. THC is selling the Medical College of Pennsylvania Hospital to East Falls Hospital System (EFHS) for exactly $1. Tenet has wanted to close MCP Hospital for two years because it is a financial sink hole that it is currently losing $5 million per month.
Area activists jumped into the fray to save the facility from closure. East Falls Hospital System was formed for the express purpose of acquiring the financially troubled facility. In a deal brokered by Pennsylvania’s governor, Tenet will now transfer non-real estate assets, including equipment, to EFHS for a buck.
As noted last month, Tenet continues to field bids for hospitals that it has not put on the auction block. A South Florida physician has again offered to buy North Ridge Medical Center in Oakland Park for $60 million.
The good doctor, who holds 25,000 shares of Tenet stock, cofounded North Ridge, so there is some sentimental attachment. But there appears to be more. When he first offered to buy back the facility, he offered an alternative in which Tenet would instead buy his 128,000-sqaure-foot Oakridge Outpatient Center nearby as well as adjacent land. In neither instance, it seems, was Tenet amused—or interested.