Dubious Timing: Are Stock Buyback Programs Really The Right Prescription For Health Care Companies?

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October 2004 issue Dubious Timing: Are Stock Buyback Programs Really The Right Prescription For Health Care Companies? Stock buyback programs can make prudent financial sense, but sometimes they can be misleading to the consumer and the investor. Excess cash may have a better use. ... Trick Or Terror? Venture Capital Slowed Down, Federal Funding For Bioterrorism Countermeasures Picked Up Venture financing has fallen off by about 25%, but has recent government funding for bioterrorism countermeasures spurred the private sector on to back similar companies? See page 1 ... Public Equity Market The public market is in better health than it has been recently, with some successful IPOs, a handful of new filings and several secondaries either completed or waiting to get priced. See page 3 ... Private Equity Market Compared with last month, the number of private placements in the health care markets is up by 57% and the total dollar volume rose 185%. See page 13 ... Departments Public Equity Market - 3 Venture Capital Market - 6-8 Quarterly Stock Chart - 10-11 M&A Announcements - 12 Private Equity Market - 14-15 Notes & Briefs - 16 Sign up for a trial subscription and get the current issue! Read the past headlines.	Dubious Timing: Are Stock Buyback Programs Really The Right Prescription For Health Care Companies? Everyone can breathe a sigh of relief, now that the presidential "debates" are over and we don’t have to decide between watching dumb and dumber or baseball. What’s not over is the debate on the future of health care in this country, specifically the cost (and availability) of health insurance, and the cost of prescription drugs. Slowing the rate of growth in health care costs is on everyone’s agenda, but how to deal with the U.S. consumer’s subsidization of the rest of the world’s cost of drugs is a murky area with few actionable ideas. The drug industry’s at times nauseating mantra states that it needs the higher prices, somewhere, in order to fund the high cost of drug research and development, which can take years and hundreds of millions of dollars for one drug candidate which may or may not ever come to market. While a valid point, the drug industry may have enough cash flow for drug development without price-gouging the American consumer, or so says a report from an analyst at Banc of America Securities. The analysis showed that during the past six quarters, the nine largest pharmaceutical companies spent close to $56 billion on stock repurchase programs and dividends, or more than the combined amount spent on new product research and development. Dividends are often popular with investors, especially mutual funds looking for current return as well as price appreciation, and share re-purchase programs are often utilized to remove excess shares in the market that are a result of options being exercised in a rising market. They are also used to bolster a company’s share price. But complaining about needing higher prices in the United States to generate the cash flow to fund drug research is a bit misleading, and we haven’t even mentioned the funds spent on direct advertising to the consumer, a relatively new phenomenon, and expense. Politics aside, pharmaceutical companies are not the only ones that invest billions in stock buybacks when there may be better uses for their funds, or at least fewer negative ramifications. Take the case of HCA Inc. (NYSE: HCA), which recently announced a $2.5 billion share repurchase plan through a tender offer for up to 61 million shares over the next three weeks. As of June 30, 2004, the company had $120 million of cash and $2.4 billion of long-term investments, but $8.67 billion of total debt. The company generates more than $2.0 billion in cash from operations before capital expenditures, but it plans on borrowing up to $2.25 billion through a new credit facility with J.P. Morgan in order to pay for the stock buyback. Management claims that "increasing the company’s financial leverage to fund the tender offer is a prudent use of our financial resources and an effective means of providing value to our shareholders," but the rating agencies beg to differ. Standard & Poor’s has said it will decrease the company’s senior debt rating from the lowest investment grade rating of BBB- to "junk status" of BB+, Fitch Ratings has made the same cut and Moody’s may be dropping its rating a notch as well. So far, several analysts have dropped their stock ratings to neutral or hold from buy or outperform, while Merrill Lynch has maintained its buy rating because of the tender offer for up to 13% of the shares outstanding, even though it has dropped its price target by $5 to $45 per share. The fact that Merrill was HCA’s financial advisor did not have any influence, of course. We understand the rationale for a share repurchase program when a company’s share price is near its 52-week low, as is the case with HCA, and the stock looks cheap relative to their internal forecasts of operating performance. But when a company announces a huge tender offer for up to 13% of its shares, with borrowed funds no less, and at the same time cuts earnings estimates for the rest of 2004 and for 2005, one has to wonder what is so rosy about the future. The bad news includes a 7.2% increase in admissions of uninsured patients, an 11.4% increase in ER visits by uninsured patients, decreasing reimbursement from managed care providers, a shift in mix to lower-paying plans and the continued deterioration in the ability to collect funds from uninsured patients. This last problem has been impacting the entire industry, but when your admissions growth is coming from patients with a declining inclination to pay, investor sentiment may be where it should be, at least with regard to HCA trading near its 52-week low. We left out the impact of the hurricane season on HCA’s Florida operations since it is basically a one-time problem. It would seem that a better use of cash, especially borrowed cash, would be to improve operations, bill collections and market position. HCA is not the only company that recently announced a large stock repurchase program. Genentech (NYSE: DNA), with $1.5 billion of cash and short-term investments on the books, announced an extension of an existing repurchase program which will allow the company to buy back up to an additional $1.0 billion of DNA common stock through the end of next year. DNA’s share price is at the lower end of its 52-week range, and management must believe it is too cheaply valued. On the other hand, Aetna’s (NYSE: AET) share price is at a 52-week high, but the company has expanded its share repurchase program by an additional $750 million. Since doubling in price in the past 12 months, we are sure that many options have been exercised, but buying the shares at twice the cost of a year ago seems to be unusual corporate financial management, to say the least. With all that extra cash around, perhaps we don’t need to have double-digit premium increases after all.
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