m&a_group assignment_group 10.doc

7/30/2019 M&A_Group Assignment_Group 10.doc

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Hospital Corporation of America

(HCA)-An LBO Story

Group 10EPGDIB 2011 - 2013

AJAY GUPTA (ROLL NO 05)HARSH GOEL (ROLL NO 30)KUNAL VERMA (ROLL NO 37)SURESH MEHRA (ROLL NO 69)


2/10

About HCA

The buyout of HCA in 2006 by a group of private investors took it from public

to private for the 2nd time. At nearly $33 billion, the buyout was the

largest on records. The exercise can be quite painstaking for such a large

corporation because of the debt capital requirement, and nevertheless-

the risk of a hostile takeover, even though it reduces the complexity of

operating a public company. But HCA already had the experience of an

MBO in 1988. It remained private from 1988-1992.

HCA (formerly, Hospital Corporation of America) was founded by physicians

Dr. Thomas Frist, (his son) Dr. Thomas Frist Junior along with Jack C Massey

in 1968 in Nashville, Tennessee. It was one of the first hospital management

companies in the US and it grew rapidly. The founders activated economies

of scale and brought many new business practices to improve quality and

reduce costs.

In 1969, the company went public. It grew rapidly in the 1970s and 80s,

through a series of acquisitions of hospitals and other similar companies. But

the economic slump of the late 1980s made it re-look its operations. The

board concurred that the Companys true value was not reflected in its share

price, and decided to buy-back the shares. The company remained closely

held till 1992, when it again went public. Thereafter, in 1994 HCA merged

with Columbia Hospital Corporation, and Richard Scott, the then CEO of

Columbia became the CEO and Chairman of the new company-

Columbia/HCA.

However, in 1997, fraudulent billing charges were pressed against the

company, which led to heavy costs over the next decade of investigations.

Scott was removed and Dr. Frist Jr. took over as the new CEO. He quickly

brought to fore, his intentions of concentrating on high end healthcare in

urban areas with high volumes, through a series of restructuring measures,

mainly through selloffs of non-hospital businesses, low growth hospitals etc.

as well as new investments in equipment and facilities. This led to huge

variations in the companys operating profits. Also, the emergency room

visits by uninsured patients had increased steeply between 2000 and 2005.


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Also, the industry had sluggish growth and lot of restructuring in 1990s and

2000s. All these factors led to low wall-street confidence bearing the stocks

down, and relatively flat profit margins and EBIDTA.

Despite all these problems, HCAs management knew that it was in an

industry of bright future, since healthcare spending per capita was only on

the rise. Also, it thought that it was well placed with the right focus at the

right time, being an industry leader in terms of size and revenue. By

December 2005, HCA had revenues of $ 24 billion and 191,000 employees.

Thus, it was thought by the management that the market did not appreciate

the true value of HCA. Thoughts of going private once again were doing the

rounds in 2005. The company went on to acquire around 100 million shares

from November 2004 to June 2006 in a series of auction tenders offers.

It was also a time when private equity firms were actively looking for

opportunities in healthcare. Table 1 shows the data of acquisitions from 2000

to 2009.

Table 1: Hospital Mergers and Acquisitions, 2000 to 2009

Hospital Mergers and Acquisitions, 2000 to 2009

Year Number of Deals Dollars Committed

2000 85 $3,773,440,000

2001 82 $3,108,119,143

2002 56 $3,403,681,000

2003 37 $2,341,550,000

2004 59 $9,706,390,279

2005 50 $2,905,728,676

2006 55 $35,533,500,001

2007 61 $9,257,130,001

2008 60 $2,580,600,000

2009 52 $1,678,800,000

Tota

l 597 $74,288,939,100


4/10

The Deal

On July 4, 2006, HCA announced that it will go private in a massive $33

billion buyout led by Bain Capital, Kohlberg Kravis & Roberts, and Merrill

Lynch. The following extract of a CNN news article from July 2006 tells the

story in numbers:

Hospital owner HCA agreed Monday to a $21 billion leveraged buyout, plusthe assumption of debt, by a group that includes private equity firms as well

as the company's founding family and members of management. Under the

deal, HCA stockholders will receive $51 in cash, a premium of 6.5 percent

from Friday's closing price, and below the price at which the stock traded in

late 2005 and early 2006. The purchase also includes the assumption of

$11.7 billion in debt. Shares had shot up in heavy trading on July 20, the day

after the Wall Street Journal reported that there had been negotiations of an

LBO, but that the deal had fallen apart in a disagreement over price. The $51

purchase price is a nearly 17 percent rise from its July 19 closing price.

Shares of HCA opened at $49.80 Monday following the announcement.

However, what was really interesting in the deal was the big bet that the

buyers made on the business model and future of HCA. The shares were

undervalued because of its recent (several years) lackluster performance.

While, this could be attributed to the industrys and HCAs turbulence, rising

costs with little pricing power etc.

But a frequent argument was that with Americas ageing population and

rising baby boomer hospital admissions, the short term forecast was great.

And medical care was an essential service, with increasing politicalprominence in a mature consumer economy. Therefore, Government

spending was expected to rise placing better pricing power in the hands of

hospital companies. In addition, Hospitals also had been able to increasingly

sell lifestyle services such as surgeries for cosmetic enhancements of body/

looks. HCA was well placed here also with its focus on urban hospitals.


5/10

Now, if we revisit, HCA, a firm founded by the family of the Republican

Senate majority leader, Bain, a firm whose founders include Massachusetts

governor and GOP presidential aspirant Mitt Romney, and KKR, a firm run by

Henry Kravis, a major Republican donor, are betting on the continued

expansion of government. HCA's sale is essentially a $33 billion investment

in the idea that government will take an even bigger role in health care.

In addition to the $5.3 billion of equity from the buyout group, the new firm

would raise an additional $20.3 billion through new bank loans and the sale

of bonds (as shown in Exhibit 3). The new HCA corporate entity would

assume certain HCA bonds with a principal amount of $7.71 billion. These

bonds would remain outstanding after the buyout. Exhibit 4 shows the

overall capital structure with $28 billion (84%) debt and 5.3 billion (16%)

equity.

Exhibit1:

Exhibit2:
http://www.opensecrets.org/indivs/search.asp?NumOfThou=0&txtName=kravis,+henry&txtState=(all+states)&txtZip=&txtEmploy=&txtCand=&txt2006=Y&txt2004=Y&txt2002=Y&Order=Nhttp://www.opensecrets.org/indivs/search.asp?NumOfThou=0&txtName=kravis,+henry&txtState=(all+states)&txtZip=&txtEmploy=&txtCand=&txt2006=Y&txt2004=Y&txt2002=Y&Order=N


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Exhibit3:


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Exhibit4:

Exhibit5:

Analysis

1. Recent performance

From Exhibits1 and 2:


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1) The overall picture at HCA is a discouraging one. Revenue growth has

slowed dramatically in the past 5 years

2) Return on equity rose in 2004, because equity dropped due torepeated large stock buybacks.

3) Return on assets has been up and down, but most recently has fallen

4) Financial leverage has generally increased, with debt growing fast

while equity does not grow

5) In general, the performance has been lackluster. Operations have

slumped, masked by rising leverage.

2. Optimal Capitalization1996 1997 1998 1999 2000 2001 2002 2003 2004 200

Revenues 18,786 18,819 18,681 16,657 16,670 17,953 19,729 21,808 23,502 24,45

Operating expenses 15,888 17,274 17,172 14,953 14,652 15,801 17,042 19,199 20,980 21,77

EBIT 2,898 1,545 1,509 1,704 2,018 2,152 2,687 2,609 2,522 2,68

EBIT margin 15.4% 8.2% 8.1% 10.2% 12.1% 12.0% 13.6% 12.0% 10.7% 11.0

Net income 1,461 182 532 657 292 886 833 1,332 1,246 1,42

Net profit margin 7.8% 1.0% 2.8% 3.9% 1.8% 4.9% 4.2% 6.1% 5.3% 5.8

1) Operating margins dropped in 1997-99 but have stabilized considerably in

the past six years

2) The litigation settlements and restructuring costs would be non-operating

items, so do not affect EBIT margin

3) EBIT margin however may be affected by excess capacity and bad debt

experience.


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3. HCA Projections for ValuationCalculation of Free Cash Flow:

Sales growth 7.4% 7.1% 7.0% 7.1% 7.2% 6.6% 6.2% 6.0% 5.5% 5.0% 5.0%

INCOME STATEMENT Proje cte d Fiscal Ye ar Ending De ce mber 31,

($ in millions except per share amounts) 2006E (b) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Revenue 25,199 27,071 28,995 31,027 33,215 35,602 37,952 40,305 4 2,723 45,073 47,326 49,693

() Operat ing expenses (exclud ing dep rec ia tion ) 21,249 23,029 24,783 26,633 28,588 30 ,733 32,761 34,793 36,880 38,909 40,854 42,897 grows with sales() Depreciation 1,393 1,446 1,538 1,632 1,734 1,842 1,964 2,085 2,210 2,332 2,449 2,571 grows with sales

(+) Other operating income 40 53 60 66 74 81 86 92 97 103 108 113 grows with sales

EBIT 2,597 2,649 2,734 2,828 2,967 3,108 3,313 3,519 3,730 3,935 4,132 4,338

(+) Non-operating income (net) 139 50 50 50 50 50 50 50 50 50 50 50 unrelated - doesn't grow

Income before income taxes 2,736 2,699 2,784 2,878 3,017 3,158 3,363 3,569 3,780 3,985 4,182 4,388

Provision for income taxes (c) 1,026 1,012 1,044 1,079 1,131 1,184 1,261 1,338 1,417 1,494 1,568 1,646 37.5% rate

Net income 1,710 1,687 1,740 1,799 1,886 1,974 2,102 2,230 2,362 2,490 2,613 2,743

EBIT margin 10.3% 9.8% 9.4% 9.1% 8.9% 8.7% 8.7% 8.7% 8.7% 8.7% 8.7% 8.7%

Other data:

Capital expenditures 1,779 1,800 1,500 1,500 1,500 1,500 1,964 2,085 2,893 2,995 3,085 3,239 PPE at cost

Reduction in deferred taxes #N/A 100 100 100 100 100 100 100 0 0 0 0 Decline stops

ASSETS

Current assets 5,867 6,303 6,751 7,224 7,733 8,289 8,836 9,384 9,947 10,494 11,019 11,570 grows with sales

P roper ty and equipm ent , at c os t: 22, 597 2 4, 39 7 25, 897 27 ,397 28, 897 30, 397 32 ,361 34, 446 3 7, 339 40, 334 43, 41 8 46, 657 Net P PE + ac cum . depr.

A cc um ulat ed de prec ia ti on 10, 832 1 2, 27 8 13, 816 15 ,448 17, 182 19, 024 20 ,988 23, 073 2 5, 283 27, 615 30, 06 4 32, 635 previ ous + d epr ec iat ion

Net propert y and equi pment 11, 765 12, 119 12, 081 11, 949 11, 715 11, 373 11, 373 11, 373 12, 055 12, 718 13, 354 14, 022 grows wit h s al es

Other fixed assets 5,691 5,691 5,691 5,691 5,691 5,691 5,691 5,691 5,691 5,691 5,691 5,691 flat

Total assets 23,323 24,113 24,523 24,864 25,140 25,353 25,900 26,448 27,694 28,904 30,064 31,283

LIABILITIES AND STOCKHOLDERS EQUITY

Current liabilities 3,279 3,522 3,773 4,037 4,322 4,633 4,938 5,244 5,559 5,865 6,158 6,466 grows with sales

Other liabilities 2,499 2,499 2,499 2,499 2,499 2,499 2,499 2,499 2,499 2,499 2,499 2,499 flat

Deferred income taxes 1,145 1,045 945 845 745 645 545 445 471 497 522 548 grows with sales after 201S tockholders equity 5, 170 6, 857 8,597 10,396 12,281 14, 255 16,357 18,587 20,950 23,440 26,053 28, 796 previous + net inc.

Tot al l iab il it ie s and s to ck holde r equi ty 12, 093 1 3, 92 4 15, 814 17 ,777 19, 847 22, 032 24 ,339 26, 776 2 9, 480 32, 302 35, 23 3 38, 310

Cash needs 11,230 1 0,190 8,709 7,087 5,292 3,322 1,561 -328 -1,786 -3,398 -5,169 -7,027

Annual cash needs -1,041 -1,480 -1,622 -1,795 -1,971 -1,761 -1,889 -1,458 -1,612 -1,771 -1,858

Free cash flow 1,041 1,480 1,622 1,795 1,971 1,761 1,889 1,458 1,612 1,771 1,858

Working capital 2,588 2,780 2,978 3,187 3,411 3,656 3,898 4,139 4,388 4,629 4,861 5,104

Net income 1,710 1,687 1,740 1,799 1,886 1,974 2,102 2,230 2,362 2,490 2,613 2,743

Depreciation 1,393 1,446 1,538 1,632 1,734 1,842 1,964 2,085 2,210 2,332 2,449 2,571

Change in deferred taxes 100 100 100 100 100 100 100 -27 -26 -25 -26

Change in working capital 192 198 209 225 245 241 242 248 241 231 243

Capital expenditure 1,800 1,500 1,500 1,500 1,500 1,964 2,085 2,893 2,995 3,085 3,239

Free cash flow 1,041 1,480 1,622 1,795 1,971 1,761 1,889 1,458 1,612 1,771 1,858

Calculation of Cost Capital:

Comparable companies:

----------------------------------------- in mil lions ------------------------------------------------------- ----------per share----------

Company Equity Beta

Short-Term

Debt

Long-Term

Debt

Shareholders

Equity

Common

Shares

Outstanding

Estimated

2006 Sales

Estimated

2006

Interest

Estimated

2006

Earnings Stock Pr ice

CVH 1.10 10 761 2,555 162.7 6,611 54 3.48 52.20

HUM 1.05 561 514 2,474 163.2 14,418 78 2.80 49.41

THC 1.00 19 4,784 1,021 469.7 9,614 408 0.15 7.32 Comparable to HCA

TRI 0.60 8 1,696 2,928 86.4 4,747 136 2.85 38.23 Comparable to HCA

UHS 0.65 5 638 1,205 53.9 3,936 48 2.70 49.45 Comparable to HCA

WLP 0.80 481 6,325 24,993 660.4 44,513 493 4.60 69.82

Company

Equity at

Market

Debt /

Equity

Unlevered

Beta

Comparable

to HCA?

Estimated

2006 Net

Income

Estimated

2006 EBIT

Net

Operating

Profit

Estimated

Tax Shield

Unlevered

Market

Value

Unlevered

P/E Ratio

Unlevered

Price/Book

CVH 8,493 0.091 1.009 No 566 960 600 289 8,975 15.0 2.70

HUM 8,064 0.133 0.927 No 457 809 506 403 8,735 17.3 2.46

THC 3,438 1.397 0.417 Yes 70 521 326 1,801 6,440 19. 8 1. 11

TRI 3,303 0.516 0.396 Yes 246 530 331 639 4,368 13. 2 0. 94

UHS 2,665 0.241 0.524 Yes 146 281 176 241 3,067 17. 5 1. 66

WLP 46,109 0.148 0.697 No 3,038 5,354 3,346 2,552 50,363 15.1 1.58

Mean unlevered beta: 0.446 16.8 1.24

Return on HCA debt at optimal capitalization = 8.27%

kD = 5.17%

Relevered beta at optimal c apitalization 0. 678

Riskfree rate 5.22%

Equity risk premium 5.00%

Cost of equity kE = 8.61%

Weighted average cost of capital WACC = 7.43%


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Terminal Value:

Perpetual growth formula 76,445 29.3 times 2016 earnings.

Comparables:

By price/earnings ratio 43,921

By price/book ratio 32,208

Perpetual growth formula= Free Cash Flow of 2017/ (WACC-Sales Growth)

= 1858/ (7.43%-5%) =76445

Valuation:

Free cash flows 1,041 1,480 1,622 1,795 1,971 1,761 1,889 1,458 1,612 1,771 1,858

Terminal value based on comparables 43,921Total 1,041 1,480 1,622 1,795 1,971 1,761 1,889 1,458 1,612 45,692

Existing offer for HCA: Shares

Value of debt and equity 32,554 Purc has e pric e of c ommon 21,170 415.098

Less existing debt 11,230 Refinance existing debt 3,520

= Value of exis ting equit y 21,324 Roll-over of exis ting bonds 7,710

Fees & expenses 910

Total uses 33,310

Our valuation is slightly below the existing offer

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