HCA record buyout raises questions of health trends on Wall Street

Observers are unsure what the long-term impact of the deal might be on HCA and other health companies.

By Katherine Vogt — Posted Aug. 14, 2006

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If the proposed $33 billion leveraged buyout of the hospital giant HCA Inc. is completed, it will go down in the record books as the largest such deal of its kind in U.S. history.

But despite its stature, there is little consensus whether the colossal deal will leave much of a footprint on the greater health care industry or on the Nashville, Tenn.-based hospital operator itself.

While many acknowledge that there are plenty of private equity companies trolling for health care companies -- and others -- to add to their portfolios, some believe that HCA was uniquely positioned to be snapped up by private investors in a way that other public health care companies are not. And though some believe that the aging baby boomer population is making health care an attractive investment for the future, others say that pressures in the industry -- particularly those on hospitals --likely will keep many suitors away from other companies in the sector.

After weeks of speculation and rumors about a possible buyout, HCA announced July 24 that it had reached an agreement to be taken private by a consortium of investors for $21 billion, plus the assumption or repayment of nearly $12 billion in debt.

"When a hospital [company] can get that big, I think that's saying [Wall Street has] accepted the fact that for-profit health care is here to stay, and there are some benefits," said Greg Moerschel, a partner with Beecken Petty O'Keefe & Co., a health care private equity firm in Chicago.

Unless someone otherwise tops the deal in a designed 50-day window, and assuming the offer withstands obstacles such as a legal challenge by certain shareholders, the hospital chain would be purchased by a consortium including Bain Capital, Kohlberg Kravis Roberts & Co., Merrill Lynch and the family of HCA co-founder Thomas F. Frist Jr., MD.

Private equity firms such as KKR became famous (or infamous, depending on the feelings of those involved) for deals such as this, in which a public company is taken off of Wall Street during a down market in hopes of taking it public again once the stock market grows more friendly. The firms make much of the payment in bonds sold to investors, potentially saddling companies with heavy debt payments that require operations to be cut or sold, and necessitating a strong IPO in the future to wipe away the debt.

This is not HCA's first leveraged buyout. In 1989 it went private in a management-led buyout for $5.1 billion. Three years later, HCA launched an IPO and returned to public trading. Like the latest deal, the 1989 deal was done in part because management saw the company's stock price dropping and considered the company undervalued.

Sheryl Skolnick, an analyst and senior vice president with CRT Capital Group in Stamford, Conn., said HCA had some unique features that likely made it attractive to the investors. It is the largest for-profit hospital chain and has a well-regarded management team, diversified assets and a potentially large cash flow stream, she said. And unlike other, smaller chains, the company is not expanding rapidly.

"They're different from all the other publicly traded [hospital] companies," she said. For that reason, she doesn't think that the deal will start a trend in the industry.

Rob Hawkins, an analyst with Stifel Nicolaus in Baltimore, said other public hospital companies aren't likely to follow suit because they have issues that make them less attractive to private investors, including legal, regulatory and financial woes and untested management teams. "Of all the firms, HCA maybe had the least number of issues that it was dealing with," he said.

Hawkins said there is a lot of private equity money just waiting to be invested right now, and some of it could land in health care companies. "They've raised a ton of money in the last two years, record funds. There's a lot of money that has to go out and be used in the next few years," he said.

Still, the relationship between Wall Street and for-profit companies that deliver health care is a fragile one. In the 1990s, physician practice management firms were briefly Wall Street darlings, only to later implode. Even the leveraged-buyout strategy has no guarantee of success. While it worked the first time for HCA, RJR Nabisco's 1989 $31-billion buyout, the previous record buyout, largely has been viewed as a financial failure.

"The real question is that with hospital margins always relatively thin, if the margins get thinner, will Wall Street become dis-enamored of the hospital industry? That could happen. It could happen at any time. Margins are thin, it is an industry that is more highly regulated than almost any other, and it is more vulnerable to the vagaries of politics," said James Unland, president of the Health Capital Group, a health care consulting firm in Chicago that does valuation and risk analysis.

Also, the Securities and Exchange Commission is continuing to investigate alleged insider trading by some company executives and major shareholders, including Senate Majority Leader William Frist, MD (R., Tenn.), the brother of HCA's co-founder. They sold shares about a month before the stock dropped 9% in one day. That was the day the company warned that earnings might weaken because of trouble collecting from uninsured patients. All accused have denied insider trading charges -- Dr. William Frist, for one, says he sold his shares to avoid any appearance of conflict of interest -- and are cooperating with the investigation.

The list of problems facing the hospital industry is long. Paul Ginsburg, PhD, president of the Center for Studying Health System Change, said it includes a growing population of uninsured patients, the looming threat of lower reimbursements from government payers and increasing competition from physicians for facilities and service lines.

The flip side is that health care has a lot of future potential. It is one of the fastest-growing sectors in the economy, fueled largely by the aging baby boomers who may need more health care services as they enter their golden years.

"There is a fundamental belief, and it's driven by demographics, that health care will continue to grow," Moerschel said. "It's not cyclical, and some might say it's anti-cyclical. Some might argue that's attractive -- combined with the consolidation -- for investors."

Skolnick questions whether the aging population will in fact increase demand for health care services because technological and medical advances could streamline care. And Unland said that even if demand for care increases, hospitals could lose out to physician competitors on their bids to provide that care.

The future at HCA -- at least the immediate future -- may be more certain. Most observers agree that there likely won't be any big changes at the hospital chain any time soon, even if the deal is completed. "This is a company that is well-run and has a reputation of having good management. So it is more of a financial thing than an operating thing," Dr. Ginsburg said.

"I think the only reason a physician might sweat is that since the company is going to be more leveraged, is there more risk of instability? Say we have a recession next year. The company could find itself in financial trouble if things don't go well," he said.

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