Community Health Bid Doomed With $2 Billion Deficit: Real M&A

Community Health Bid Doomed With $2 Billion Deficit
Signage is displayed outside of Tenet Healthcare's Atlanta Medical Center in Atlanta, Georgia, U.S. Photographer: Erik S. Lesser/Bloomberg

Community Health Systems Inc. may have doomed a proposed takeover of Tenet Healthcare Corp. when its third offer was still so low that it would need to be raised by almost $2 billion to be on par with past hospital deals.

Community Health boosted its unsolicited bid for Tenet on May 2 to $7.25 a share in cash, or $7.3 billion including net debt, according to data compiled by Bloomberg. That values Dallas-based Tenet at 7.4 times earnings before interest, taxes, depreciation and amortization, the cheapest hospital acquisition since 2003, the data show. To reach the median 9.3 times Ebitda for takeovers in the industry greater than $500 million, Community Health would have to pay $9.2 billion, the data show.

After Tenet attempted to thwart the deal by accusing the Franklin, Tennessee-based company last month of overcharging the U.S. Medicare program, Community Health raised the bid to its “best and final offer” and set a May 9 deadline for “good-faith” discussions -- four days ahead of the first hearing in the case. While Tenet risks some of its 46 percent stock gain since the original December bid by walking away, the company may still draw interest from HCA Holdings Inc., the largest publicly traded U.S. hospital company, according to Michael Wiederhorn, an analyst at Oppenheimer & Co.

“My opinion is that it will be dead,” said Keith Moore, an event-driven strategist at MKM Partners LP in Stamford, Connecticut. The offer of “$7.25 is not going to be enough to bring the Tenet board to the table and say they’re willing to negotiate,” he said.

‘Best and Final’

Tenet’s stock slid 9.5 percent to $6.27 through yesterday since Community Health boosted its offer to $7.25 a share, signaling traders don’t think the sweetened bid is enough to get the deal done. The stock advanced 2.1 percent to $6.40 at 11:42 a.m. on the New York Stock Exchange, while Community Health climbed 2.3 percent to $30.26.

“We made our best and final offer based on the information currently available to us and set the May 9 deadline to bring this matter to a prompt conclusion in the best interests of all concerned,” said Brooke Gordon, a spokeswoman for Community Health.

Rick Black, a spokesman for Tenet, said that Tenet hasn’t responded yet to the higher Community Health bid. He declined to comment on speculation Tenet might be a good fit for HCA. Ed Fishbough, an HCA spokesman, declined to comment.

Tenet, with operations primarily in urban markets such as Philadelphia and Miami, operates 49 acute-care hospitals and 84 outpatient centers, mostly located in the South, according to the company’s website.

29 States

Community Health’s affiliates own, operate or lease 130 hospitals in 29 states, serving non-urban and mid-sized markets, according to its website. A union would create the largest hospital company in the U.S. based on number of hospitals, data compiled by Bloomberg show. Community Health is now the second-biggest after Nashville, Tennessee-based HCA.

Tenet had risen as much as 27 percent above Community Health’s original offer of $6 a share in cash and stock as traders bet on a higher price or competing bid. Even after Community Health revised the proposal on April 18 to all cash, the stock still traded as much as 16 percent above the bid.

Community Health’s most recent bid valued Tenet’s equity at about $3.5 billion, or 3.2 times net income -- the lowest since at least 1999 among hospital takeovers greater than $500 million, data compiled by Bloomberg show.

“At this point there’s an extremely low likelihood of there being any kind of Tenet-Community deal,” said Abigail Hooper, a managing director at Havens Advisors LLC, a New York-based merger arbitrage fund manager.

Relative Value

Including about $3.8 billion in net debt, the total value of the deal is 7.4 times Ebitda of $987 million in the 12 months before a bid was made. That’s the cheapest in the industry since Afrox Healthcare Ltd. was purchased for $3.53 billion rand ($525 million), valuing the Johannesburg-based hospital operator at 5 times Ebitda, the data show. The deal was announced in November 2003 and completed in March 2005.

“The $7.25 bid is still too low given the multiples for the industry,” said Art Henderson, an analyst at Jefferies & Co. in Nashville.

Henderson said Tenet should be worth about $9.50 a share, while Sheryl Skolnick, an analyst at CRT Capital Group LLC in Stamford, Connecticut, said Tenet should trade at about $9.

‘Blowing Up’

Community Health first submitted a bid on Nov. 12 to Tenet Chief Executive Officer Trevor Fetter, 51, and the board. It was made public Dec. 9 after Tenet rejected the offer on Dec. 6. Tenet’s response has been “scathing” from the start, said Graham McPhail, an equity analyst at Baltimore-based T. Rowe Price Group Inc., which owns shares of Tenet and Community Health.

“There is nothing in the track record of Tenet’s management that would lead me to believe that they will be reasonable enough to go to the table,” McPhail said. “Trevor should be working to maximize shareholder value, but from the start he has only seemed intent on blowing up the offer.”

In a statement released after Community Health made the unsolicited offer public on Dec. 9, the Tenet board said it doubted Community Health could “integrate and operate a business like Tenet” and called the bid an “opportunistic proposal” that would “transfer the growth potential inherent in Tenet to Community Health without adequately compensating Tenet shareholders.”

‘All Hands’

Tenet accused Community Health of overcharging Medicare at least $280 million between 2006 and 2009 in a lawsuit on April 11. Tenet said the rival hospital company was using “liberal” criteria to decide whether to admit a patient or treat the person less expensively on an outpatient basis. The next hearing is set for May 13.

Community Health disclosed April 15 that it had been subpoenaed by the U.S. Department of Health and Human Services in connection with an investigation into possible improper billing of Medicare.

“Even though they won’t say it, they need all hands on deck -- not to pursue Tenet at this point, but to pursue these allegations,” said Sachin Shah, a special situations and merger arbitrage strategist at Capstone Global Markets LLC in New York. “They want this Tenet situation to end.”

Justice Department

Tenet has its own history of government probes. The company paid more than $900 million as part of a 2006 settlement with the Justice Department after the company was accused of overbilling Medicare and other federal health programs. It also paid a $10 million fine to the U.S. Securities and Exchange Commission in 2007 for accounting fraud claims, and in March settled a class-action complaint over the firm’s management of Memorial Medical Center in New Orleans during Hurricane Katrina.

The company is now in play, and HCA may be a good fit, said Scott Rostan, a former M&A banker at Merrill Lynch & Co. and president of Training The Street, which trains new hires at firms from Zurich-based Credit Suisse Group AG to Blackstone Group LP of New York. Oppenheimer’s New York-based Wiederhorn said HCA, as well as private-equity firms, may pursue Tenet.

HCA, which posted Ebitda of $5.67 billion last year, could boost earnings by as much as $800 million annually by acquiring Tenet, CRT Capital’s Skolnick said.

The company has 164 hospitals and 106 surgery centers in 20 states in the U.S. and U.K., according to HCA’s website. HCA raised $4.4 billion in its initial public offering in March after being taken private in 2006 for $33 billion by a private-equity group including Bain Capital LLC of Boston and New York-based KKR & Co.

‘Perfect Sense’

“HCA strategically makes perfect sense,” Rostan said. “You have a financial sponsor-backed HCA, but it would get the benefit of a strategic acquisition with the overlapping operations and potentials for cost savings.”

If Community Health isn’t successful in acquiring Tenet and HCA doesn’t make an offer, Tenet’s stock may drop as much as 16 percent to $5.25, MKM’s Moore said. Tenet had fallen 9.9 percent in the 12 months leading up to Community Health’s first offer.

Since then, Tenet has reported earnings that topped analysts’ estimates for two quarters. It posted a $1.14 billion profit last year, a six-fold increase from 2009.

Tenet “was definitely in a real trough when they came in and no company likes to sell based on the price of their stock during the trough,” Moore said. “What Tenet was counting on was to get the fundamentals to turn around enough and the financials to show enough progress that even the $7.25 bid wouldn’t look attractive.”

Overall, there have been 8,428 deals announced globally this year, totaling $834.7 billion, a 23 percent increase from the $677.9 billion in the same period in 2010, according to data compiled by Bloomberg.

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