Ready for Obamacare, Hospital Chains Join Forces

Eileen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With the Affordable Care Act set to take effect, hospitals are scrambling to buy up rivals that complement their businesses. One of the latest mergers involves Health Management Associates (NYSE: HMA) and Community Health Systems (NYSE: CYH). Community Health Systems, or CHS, is a leading operator of general acute care hospitals with more than 135 hospitals in 29 states and about 20,000 beds. Health Management runs 71 hospitals in 15 states with approximately 11,000 beds. The company has a strong presence in the Southeast, one-third of the company’s hospitals are in Florida. By purchasing Health Management, CHS will expand its presence in Florida.

If the deal is approved, CHS will pay $7.6 billion in cash and stock for Health Management and assume $3.7 million in debt. CHS will pay $13.78 for Health Management’s outstanding shares and, pending the resolution of certain legal matters, up to an additional $1 per share. Current Health Management shareholders will end up owning about 16% of the combined company. The resulting merged business will own or operate 206 hospitals in 29 states with over 31,000 beds.

Major shareholder disapproves of so-called cheap deal

Glenview Capital Management is a major shareholder of Health Management and owns 15% of the company’s stock. The firm is asking for more time to review the details of the deal, finding the offer to be a “floor value” for the company. The price offered reflects 8.3 times trailing cash flows. Health Management shares have risen about 43% this year, but fell 11% on July 30 to close at $13.30. Analyst Sheryl Skolnick, of CRT Capital Group, told Bloomberg the acquisition is “realistic” for shareholders, finding the company’s fundamentals to be bad enough to warrant a below market price.

Consolidation expected to help hospitals in a challenging environment

Both CHS and Health Management have been targeted by federal investigators for a variety of issues, such as physician referrals, medical necessity of emergency room tests, and admissions practices. Both companies have also been dealing with lower admissions – Health Management predicts admissions for 2013 to drop between 3% to 4.5% and CHS reported lower same-store admissions in the second quarter by 5.7% and lower adjusted admissions by 2.6% compared to last year. After the merger finalizes in the first quarter of 2014, a neutral effect is expected on EPS during 2014, followed by an accretive effect on earnings.

Health Management’s preliminary net revenue for the second quarter is expected to range between $6.8 billion and $7 billion with diluted EPS of $0.59 and $0.70 per share. Net revenue is expected to decline by $74 million due to lower adjusted admissions from shifts in payors mix, reduced number of surgeries, higher bad debt, a greater number of observation stays, and the effects of sequestration.

Second quarter net income attributed to CHS dropped by 64% to $29.8 million, or $0.32 per share, compared to $83.4 million, or diluted EPS of $0.93, in the second quarter of 2012. The period also had a 5.1% decrease in total admissions and a 1.8% decrease in total adjusted admissions. CEO Wayne T. Smith commented on the company’s ongoing challenges of weak patient volume in May and June, high levels of bad debt, and a declining payor mix. The company is focused on managing expenses and implementing volume initiatives.

Rival HCA buys hospitals in Florida

HCA (NYSE: HCA), or Hospital Corporation of America, which operates about 163 hospitals and 109 freestanding surgery centers, had initially shown interest in acquiring Health Management. Instead the company has purchased from IASIS Healthcare three hospitals located in the Tampa Bay, Florida area. The hospitals will join HCA’s West Florida division and add 691 beds. With the purchase, the West Florida division expands to 19 hospitals and 16 ambulatory surgery centers and should attract patients located in Tampa Bay and St. Petersburg.

HCA’s results in the second quarter were better than its competitors with revenue of $8.45 billion, up 4.2% from $8.11 billion in the second quarter of 2012. Second quarter net income per diluted share came in at $0.91 compared to $0.85 in 2012. The hospital operator’s same facility admissions for the quarter increased 1.3% and same facility equivalent admissions rose 1.1%. 

My Foolish conclusion

The three companies mentioned have approximate five-year growth rates between 10% and 12%. With the changes expected next year and brought on by the Affordable Care Act, it may be wise to sit on the sidelines and watch how these companies navigate through this new regulatory environment. It will also be interesting to see the outcomes and resolution of the legal matters affecting CHS and Health Management. The hospital chains that achieve positive results may warrant a purchase near the second half of 2014.

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Eileen Rojas has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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