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The Private Life of HCA

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When a consortium of private equity investors and HCA management closed a deal to take the nation’s largest for-profit hospital chain private last November, it marked the second time founder Dr. Thomas Frist Jr. and his management team had engineered a deal to privatize the company. This time, it cost investors $33 billion—at the time the largest leveraged buyout ever.

And that’s the key metric for many observers: leverage. Specifically, the high debt load (seven times cash flow) the company took on to execute the deal with Bain Capital, Kohlberg, Kravis Roberts & Co. and Merrill Lynch Global Private Equity.

“The increase in leverage results in a decrease in financial flexibility,” says Dean Diaz, vice president and senior credit officer with Moody’s Investors Service in New York. “The company’s ability to meet some of the challenges in the sector related to bad debt issues and volume trends has been diminished.”

That may be so, but Frist and Chief Executive Officer Jack Bovender have a record of taking private what they see as an undervalued company and redeploying it to the public markets after reshaping it. HCA went private once before, in 1989, as Frist and HCA management teamed up with financier Richard Rainwater for a $5.1 billion LBO at a time when the company was concerned about a hostile takeover. The fact that the same company could be taken private 17 years later at more than six times that amount shows Frist & Co. did pretty well with that initial decision.

Pay off and refocus

Some observers expect that HCA will want to leverage higher still—and relatively soon—to buy out its equity partners Bain, KKR and Merrill with a dividend. “If you’re not going to take out big management fees, which they say they aren’t, you’re not going to sell a lot of assets. And if you acknowledge that it’s a well-run company, how do you get your return if you’re one of the sponsor groups? The answer is a dividend deal,” says a director at a major investment bank who did not want to be named.

Even if a dividend deal isn’t in the works, given the equity stakes that Frist and management have in the company, the private equity partners aren’t likely to damage the company’s future by taking outsized management fees or selling assets in a fire-sale manner.

Though HCA isn’t saying much—one benefit of going private is that you no longer have to answer to public shareholders, Sarbanes-Oxley or the media—many expect the largest operator of acute-care hospitals to sell some assets over time. The company may pare down its underperforming hospitals and perhaps give up the “largest acute-care hospital company” banner. There is some precedent for that strategy; then-Columbia/HCA once owned 318 acute-care hospitals, 145 surgery centers and 550 home health agencies, but has pared down significantly since then to 173 acute-care hospitals and 108 surgery centers.

“Frist said several years ago that 120 chain hospitals would be about right,” the investment banker says. “I’m not suggesting they sell 30 percent of their hospitals, but I am suggesting that paring down the company and selling off markets where they haven’t had as much success as they’d like to might be in their plans.”

Keeping the ‘Hospital’ in HCA?

Some experts have speculated that HCA might get out of the surgery center business entirely, an idea one commentator calls “idiotic” given the increased focus by all hospitals in strengthening their relationships with their physicians and employing them. Still, the company will then likely have to sell off some part of its business and perhaps go public again at some point to pare down its debt, which has been downgraded to junk status by the major rating agencies.

“I wouldn’t expect a meaningful decrease in the amount of debt outstanding to come through operations,” says Moody’s Diaz. “It would have to come through either a return to the public markets or through divestitures.”

But for now, Richard M. Bracken, HCA president and chief operating officer, is careful to continue to operate below the radar concerning the company’s plans.

“Public or private, our strategy has been to have leading facilities in urban and suburban locations in some of the fastest-growing, large population centers in America,” he told HealthLeaders in an e-mail.

But will HCA, which certainly hasn’t pared back its aggressive recruitment of physicians, feature an increased emphasis on surgery centers or perhaps even smaller, short-stay general acute-care hospitals that don’t have the liabilities of big emergency rooms and have less exposure to the bad debt issues that have plagued HCA as a public company? Bracken’s not telling. “We feel we’re well-positioned for future growth. It is this strategy, developed by HCA’s management team, that made HCA attractive to our investors,” he says.

It’s sure to be a strategy that, if the past is any indication, might make the company attractive once again to the public markets—in three to five years.

Philip Betbeze is finance editor with HealthLeaders. He can be reached at pbetbeze@healthleadersmedia.com.