As expected, Tenet Healthcare Corporation (NYSE:THC) rejected the latest all-cash $6 per share offer from the Community Health Systems (NYSE:CYH). Here are the reasons, according to company’s press release, quoting Trevor Fetter, President and CEO of Tenet:
“Community Health’s proposal continues to undervalue Tenet. Since Community Health’s original $6.00 per share proposal was made, Tenet has demonstrated improving business trends, including the best fourth-quarter results in seven years. In addition, industry fundamentals are improving, and Tenet’s Outlook for 2011 and longer-term financial performance reflects strong growth.”
Earlier on, I stated neither THC nor CYH is a bargain at these prices. Within the margin of error, the two hospital owners are fairly valued.
The question which company presents better value? And is there basis for Tenet’s management that the current offer grossly undervalues Tenet?
One can put the two companies side by side:
|Comparison Between THC and CYH|
|Market Value ($mil)||3,290||2,847|
The two companies are of comparable sizes in terms of revenue and market cap. Community Health is destined to double its size in this one deal. The move is quite a deviation from the company’s stated typical criteria as disclosed in its 2010 annual report, which says (page 5): ”Each year we intend to acquire, on a selective basis, two to four hospitals that fit our acquisition criteria.” Tenet operates 49 acute care hospitals and 84 outpatient centers. Maybe Community Health found compelling value in its Tenet, for it is ready to change its mind and pursue the company with all earnest.
The truth is, at current prices (those of Thursday, April 21, 2011), Tenet is selling at higher P/E, P/S, and P/B ratios, by large margins, than Community Health — so much for the compelling value.
In order to buy Tenet, Community Health is going to borrow more money. In rejecting Community Health’s offer on Dec. 9, 2010, Tenet used this point for its own defense:
III. Community Health’s willingness to operate with excessive leverage creates an overhang on the stock and could cause a significant decline in value.
Community Health already operates with a debt to EBITDA ratio that is the highest in the hospital industry and this transaction would further weaken your balance sheet. Our Board does not believe it is in our shareholders’ interests to receive stock in a company with excessive leverage and a risky capital structure. Based on your proposal, Community Health’s debt would exceed $15 billion, a very high absolute number on an equity value barely one-fifth of that. In addition, while you have structured your proposal to avoid giving your shareholders the opportunity to vote on the matter, we question whether they would support such a highly leveraged capital structure. Importantly, we believe Community Health shareholders would be adversely impacted by the increase in leverage and interest expense and the negative impact on free cash flow that would result from the proposed transaction. We believe that the cost of re-pricing your short-term debt to market rates may cause you to incur in excess of $120 million per year in additional interest costs.
On a pro-forma basis, Community Health’s leverage would be significantly higher than it is today, and significantly higher than any other hospital company. In fact, Community Health’s leverage following your proposed transaction would be higher than all but a handful of companies in the S&P 500. This calculation does not even incorporate the effects of your recent acquisitions of three bankrupt hospitals, a new $300 million hospital you propose to build in Birmingham, and any other acquisitions of non-profit hospitals you currently have in the pipeline. When this high leverage is combined with the nature of your capital structure (i.e., the short-term floating-rate nature of a substantial portion of your debt), we do not believe this would be an appropriate risk to recommend that our shareholders assume.
The Tenet management seems to have the right idea when comes to assessing the risk of the acquirer, although its own debt level is rather high as well.
The Tenet management’s holdout may eventually improve its shareholders’ position somewhat. The offer is for $6 per share and the stock is selling at $6.77, so much of the improvement is already reflected in the price.
On the other hand, the management of the Community Health really needs to examine the value of the target company, for it is certainly not a compelling bargain.
As a retailer investor, I have to wonder why Community Health is persistent in pursuing the deal and why Tenet is reluctant in accepting a seemingly fair deal.