July 31 In many U.S. industries, a potential acquirer would balk at the idea of buying a company mired in a government investigation, let alone featured on the television news program "60 Minutes" for its troubles.
But in the hospital space, where gaining scale is crucial to survival, Community Health Systems is not letting Health Management Associates' legal woes hamper a buyout.
On the same day that the two companies unveiled their $3.9 billion deal, Health Management also announced it had received more subpoenas in a widening federal investigation into its practices for admitting patients.
"In any other industry, it might be as effective a poison pill as any," said CRT Capital Group analyst Sheryl Skolnick. "In the hospital industry, apparently it is not."
Community Health knew of the extra subpoenas coming down the pike and had gained a good understanding of the legal risks facing the company during its due diligence process, its executives said on a conference call Tuesday.
In fact, the deal was structured to include a provision called a contingent value right worth up to $1 per share to HMA shareholders, or $268 million, depending on the outcome of the government's probe and the size of any resulting fines and legal fees.
Looked at another way, if not for the government investigations, the bid price would have been $1 a share higher, Skolnick said.
"The shareholders of HMA are going to have to bear $1 per share for the risk that their company, their board, created that allowed the conditions to exist that enabled those investigations to take place," she said.
Community Health is no stranger to such scrutiny either. The company is under investigation by the U.S. Department of Justice over how it handles patients enrolled in the government's Medicare plan for the elderly.
SCALE IS KING IN HOSPITAL SPACE
Hospitals are bulking up to gain a stronger position in negotiations with health insurers, reinforce their presence in local markets, and ultimately brace for diminishing payments from government programs such as Medicare and Medicaid as the United States overhauls its healthcare system.
Last month, No. 3 hospital chain Tenet Healthcare Corp said it was buying Vanguard Health Systems Inc for $1.73 billion. Community Health is the second-largest, for-profit U.S. hospital operator, behind HCA Holdings Inc .
"Scale in this industry is critical because your primary payer, the government, is going to be cutting reimbursement for the foreseeable future and you have to be more efficient," said one person familiar with the acquisition, who wished to remain anonymous because he is not permitted to speak to the media. "It is much easier to drive efficiencies through a combination than it is trying to re-engineer your existing business."
The acquisition is already facing opposition from one of HMA's largest investors, hedge fund Glenview Capital Management, which owns a 14.6 percent stake in the company.
Hours after the deal was announced, Glenview, which has been waging a battle to replace HMA's board, said it would still prefer to see new directors installed and the company's operations improved before the final value of the enterprise is determined.
"It is difficult to assess whether the value offered in the Community proposal represents full and fair value, or represents the price offered by an opportunistic acquirer to a distressed seller," Glenview said in a statement.
Community's chief executive, Wayne Smith, and HMA's CEO Gary Newsome, first met to discuss a potential combination last fall, people familiar with the deal said.
In June, HMA announced it had hired Morgan Stanley and law firm Weil, Gotshal & Manges in response to the push by shareholder Glenview Capital. As a result of that announcement, HMA received expressions of interest from a handful of parties, including Community, one of the sources said.
STOPS AND STARTS
HMA's legal woes did result in some "stops and starts" in the discussions between Community and HMA," said the person familiar with the deal.
The U.S. Securities and Exchange commission is investigating HMA's financial statement disclosures and accounting practices. In December, it was the subject of a story on the "60 Minutes" CBS television program that claimed it used aggressive policies to boost patient admissions. Health Management denied the assertions.
On Tuesday, HMA disclosed additional subpoenas from the U.S. Department of Health and Human Services about emergency room operations and from the Office of the Inspector General on physician relationships.
To some extent, Community had a particular understanding of HMA's issues, which may have given the larger hospital operator some level of comfort, said the person familiar with the deal. Federal investigations at both companies focus on whether the hospitals are admitting people they shouldn't.
Community suggested the contingent value right (CVR) as a way of protecting its shareholders from the liabilities, the sources familiar with the deal said.
The CVR essentially works as an escrow account protecting Community from HMA's legal liabilities. Every shareholder gets one contingent value right worth up to $1. The first $18 million of legal settlement fees will be paid by Community. After that, for every dollar of losses, the CVR is reduced by 90 cents of the dollar for HMA shareholders, and by 10 cents for Community. If legal settlement losses surpass $316 million, HMA shareholders will not get any value from the CVR.
For Community, buying another hospital operator mired in legal issues should not concern its investors too much, since they have already considered the risks involved in holding stock in a company facing a government probe, said Jefferies analyst Brian Tanquilut.
"If you are willing to own Community knowing they are under investigation, then it means you are willing to take on the investigation risk that comes along with it," Tanquilut said. "So this deal for HMA should not be that different."