How Will This Deal Affect the Healthcare Industry?

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

Franklin, Tennessee-based Community Health Systems (NYSE: CYH) is on the cusp of picking up an attractive prize in its favored healthcare niche. According to reports, the company will pay about $4 billion in cash and assume nearly as much debt to merge with Health Management Associates (NYSE: HMA). The combination will create a sizable healthcare system that could be better-positioned to compete in the rapidly changing U.S. healthcare landscape.

Although this deal is subject to customary closing conditions, most impartial observers expect it to pass regulatory muster and win the approval of shareholders. Investors should hope that this is the case: Unlike some recent hospital-company mergers, this transaction features some attractive synergies and could serve as the basis for a period of rapid expansion. On the other hand, both firms carry significant amounts of debt and must compete with even larger hospital systems that may enjoy a competitive advantage in the post-ACA milieu.

About Community Health Systems, Health Management Associates, and the competition

Community Health Systems has a larger headcount and bed count than its acquisition target, but both firms are well-known players in the American healthcare landscape. Community Health Systems owns hospitals and clinics in 29 states and maintains a robust "core" of operations within a fairly tight radius of its Tennessee headquarters. With clinics and hospitals in around 20 states, Health Management Associates also focuses on serving the Southeastern and Mid-Atlantic regions of the United States.

In fact, Health Management already operates in all of the states in which Community has a presence. Both firms provide similar services, including full-service hospitals, walk-in clinics, outpatient specialists' practices, surgical centers, cancer treatment facilities and more. 

These firms must compete with the much larger HCA Holdings (NYSE: HCA). While Nashville-based HCA's U.S. operations are virtually indistinguishable from those of Health Management and Community, it also has a significant presence in the United Kingdom. Since it must simultaneously thrive in the U.K.'s single-payer healthcare environment and the U.S.'s market-based system, this gives it much-needed flexibility. If it is to perform well, the combined firm will need to learn some lessons from HCA.

HCA's market capitalization of $18.1 billion is just over five times larger than that of Health Management and just over four times larger than that of Community. Its 2012 earnings of $1.4 billion produced a 4.3% profit margin on revenue of $33.4 billion. Health Management managed a measly 2.5% margin on $156 million in earnings and $5.9 billion in revenue. With a profit of just $216 million on $13 billion in revenue, Community was even less profitable. Meanwhile, all three firms have at least 10 times as much debt as cash.

How the deal is structured

At the moment, the terms of this deal are quite favorable to Health Management's shareholders. Community has agreed to issue cash payments of $13.78 to all Health Management shareholders on the deal's closing date. It will also provide the company's shareholders with contingent value rights that could add an extra $1 per share to the deal's effective price. Without the contingent value rights, Community's offer currently represents a premium of around 3%. The addition of the CVR increases this premium to about 10%.

Reasoning, synergies, and benefits

Hospital companies are still formulating their responses to the implementation of the Affordable Care Act. Since it is generally assumed that hospital systems will need to accept lower profits and tighter margins, many small and medium-sized firms are preemptively forming scaled-up alliances that may be better-positioned to compete in a more dynamic marketplace. 

This deal will certainly create beneficial synergies for the combined company. Once it has subsumed Health Management, Community may be able to centralize some of its operations or even close some of its smaller, less profitable facilities. In addition, it may choose to experiment with different types of data-collection systems and join the movement to "farm out" certain menial medical tasks to "correspondence" facilities in low-cost overseas locations.

Potential hurdles and complications

While most market-watchers believe that Health Management and Community will merge on schedule, the persistent discount at which Health Management trades suggests that some doubt remains. Since Health Management's shareholders must still approve approve this deal, it would be unwise to engage in premature celebration. In the meantime, Health Management's low valuation offers a tailor-made arbitrage opportunity.

Ways to play

Arbitrage investors would be wise to buy into Health Management before the premium disappears. Those who wish to hedge against the possibility of a collapsed or stalled deal may wish to use put options or other risk-mitigation tools as well. In the event that the combined firm triggers the CVRs by meeting certain agreed-upon sales goals, such a move could pay off handsomely.

Even without the additional premium, the long-term prospects for this merger look attractive. As such, value investors might wish to play the situation with a long position in either firm. In a U.S. healthcare space that has been wracked by uncertainty and apprehension, this deal truly offers something for everyone.

Obamacare is rewriting the rules for the health care industry, and in the process of doing so, it's creating massive opportunities for investors to get ridiculously rich. How? By investing in a handful of specific health care stocks. In this free report, our analysts walk you through these opportunities and the companies that are positioned to exploit them. The informational edge contained in it is invaluable, but can only be exploited profitably while the rest of the market remains in the dark. To access this free report instantly, simply click here now.


Mike Thiessen 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure