The Health Care M&A Monthly: One For the Record Book--

HCA Agrees To Be Taken Private For $33 Billion

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For the second time in its history, hospital operator HCA, Inc. (NYSE: HCA) has agreed to be taken private. This time a group of private equity firms, along with HCA management and the founding Frist family, have banded together to form a consortium to buy out the hospital giant. Valued at $33 billion, this deal is one for the record book, though not the one most observers have thought.

HCA, whose roots reach back to 1969, has grown into the country’s largest owner and operator of acute-care hospitals and related health care facilities. Though publicly traded for most of its life, it was taken private for three years in the late 1980s, only to go public again. Its largest growth spurt took place in the mid-1990s under the leadership of Richard L. Scott, when it swallowed up company after company and finally emerged with the name Columbia/HCA Healthcare Corp.

By 1997, Columbia/HCA had 318 acute-care hospitals, 18 psychiatric hospitals, 145 outpatient surgery centers and 550 home health agencies, among other assets. It operated hospitals across the U.S., and in England, Spain and Switzerland. In 1997 it generated revenue of $18.8 billion and a net loss of $305 million. That year’s loss was a clear symptom that the strategy of growth for growth’s sake was not delivering financially, particularly at a time when reimbursement protocols were undergoing a major overhaul, so the company set out to reinvent itself. It spun out two of its five divisions into separate companies, LifePoint Hospitals (NASDAQ: LPNT) and Triad Hospitals (NYSE: TRH), divested noncore business lines, undertook a corporate rebranding and shuffled senior management, notably removing the empire-builder Scott from the helm.

As led today by CEO Jack Bovender, HCA now operates 172 hospitals, 92 outpatient surgery centers and affiliated services. On a trailing 12-month basis, it generated annual revenue of $25 billion, EBITDA of $4.1 billion and net income of $1.3 billion.

This July a consortium of private equity firms announced a plan to buy HCA and take it private in a leveraged buyout. The consortium consists of such notables as Bain Capital; Kohlberg, Kravis Roberts & Co. (KKR); and Merrill Lynch Global Private Equity. Joining them are HCA management and members of the Frist family, whose late patriarch Thomas Frist, Sr. started it all. In short, they propose to offer $51.00 for each share of HCA common stock outstanding and to assume $11.7 billion in debt, for an overall purchase price of $33 billion.

This proposal offers shareholders an 18% premium to the stock’s price the day before rumors started flying about the deal. This is in line with the average 20% premium that had been offered for acquisitions during the first six months of 2006. The acquisition multiples should give us pause because of their, well, skimpiness. The price to revenue multiple is 1.3x and the price to EBITDA multiple is 8.1x. These are the kinds of multiples that single, well-run hospitals have been commanding in recent transactions, making it appear that there is virtually no acquisition premium for being the largest company of its kind.

So why do this deal? And who benefits from it? Clearly, the bankers will get juicy fees, and ordinary shareholders get a little bang for their buck. Going private will give management a freer hand to concentrate on operations, which may include selling off underperforming facilities, rationalizing staffing, increasing admissions and containing the impact of uncollected bills, all without having shareholders peer over management’s shoulders for quarter-to-quarter earnings. Well and good. Maybe the people at the private equity firms know something more about operating hospitals than Mr. Bovender, but it’s hard to see what that could be. Maybe management is anticipating an upcoming recession and is battening down the hatches in this move. Fine. All are reasonable enough explanations in the current operating environment for going private, but what about the exit strategy?

Part of the secret lies in the low acquisition mulitples noted above. If HCA can ultimately be taken public again at, say, 10x EBITDA, the investors will have real realized a very tidy return for themselves. To finance this deal, however, about $5.5 billion is being paid in cash, with debt making up the difference, making HCA a highly leveraged company. The investors are likely banking on cash flow to service debt, but it is also needed for capital projects at the hospitals, so it may take some effort and creative financing to get the higher multiple when taking HCA public again, in whole or in parts. Rumors have circulated that The Blackstone Group might mount a sweetened counteroffer for HCA, but a higher price would only cut into the returns, perhaps modest, contemplated in the current offer.

One waggish online commentator, Daniel Gross, has suggested the possibility of a political connection. He noted that Senate Majority Leader Bill Frist is related to HCA’s founding dynasty; that Massachusetts governor and Republican presidential aspirant Mitt Romney is a founder of Bain Capital; that Henry Kravis of KKR is a major GOP donor. All of them, he speculates, are betting on the continued expansion of government spending on health care. Could it be that the GOP is leaning towards, gasp, universal health care to increase the funds flowing into hospitals? (And if Hillary is derailed in the process, so much the better.) While this tongue-in-cheek scenario owes more to those amusing conspiracy theories that dot the Internet than to hard fact, we are left scratching our heads to see whether there is anything more concrete or compelling motivating the deal.

This deal has naturally raised the spectre of other hospital companies being targeted by LBOs. Universal Health Services (NYSE: UHS) has come out with a statement that while it is always looking for ways to enhance shareholder value, an LBO isn’t in the works. We are just as sanguine about other players such as Community Health Systems (NYSE: CYH) and Triad, although Health Management Associates (NYSE: HMA) seems a bit vulnerable these days with analysts lowering ratings.

It has been stated that this is the largest leveraged buyout in history, edging out KKR’s $31.3 billion buyout of RJR Nabisco in 1989. It is not, at least not in real terms. The $31.3 billion spent in 1989 would have an adjusted buying power today of $50.8 billion in today’s market. What is certain, though, is that this is the single largest hospital deal, buyout or not, ever undertaken. And if it closes, it will crown 2006 as the year with the greatest dollar volume in the hospital M&A market.
 

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