Following the "big is better" drive toward consolidation, National Medical Enterprises last week agreed to buy American Medical International in a $3.3 billion deal.
Yet the acquisition-which will saddle NME with $2.5 billion in additional debt-carries significant costs, such as $150 million in transaction fees. That's prompted some to question whether the underlying reason for hospital consolidation-cutting costs-may have been lost in the lust for size.
"Big is better if you're big in the right places, and I'm not sure they are," said John Runningen, first vice president of Robinson-Humphrey Co., an Atlanta-based investment banking firm.
Charles Martin, chairman of OrNda HealthCorp, a Nashville, Tenn.-based chain of 46 hospitals in 15 states, suggested last week that the industry may merely be going through a phase of "size for the sake of size. One day, small will be beautiful again."
Undoubtedly, consolidation has swept the hospital industry, especially in the for-profit sector, where 10 investor-owned companies will have merged into three by early next year. By next February-when the Columbia/HCA-Healthtrust and NME-AMI deals are expected to be completed-those two chains will control 61% of the 122,000 for-profit beds in the United States.
The acquisition of AMI will make NME an 84-hospital chain with $5.3 billion in annual revenues. The new company-whose name will change from NME-will rank second behind Columbia/HCA Healthcare Corp., which has 195 hospitals and will increase that to 311 when it acquires Healthtrust (Oct. 10, p. 2).
Heavy price.Boosting NME's size will carry a price. For example, the $150 million in transaction costs looks top-heavy when compared with the estimated $60 million in annual savings to be reaped from the deal. Using those numbers, it will take 21/2 years of savings from the merger to pay all the lawyers, investment bankers, accountants, and mergers and acquisitions experts.
A significant portion of those fees will be in refinancing. The Santa Monica, Calif.-based company will finance $2.9 billion of the transaction in cash. The company expects to issue $900,000 in senior and subordinated bonds, and receive a new $2 billion credit facility to refinance some existing AMI and NME debt.
As for the fees, those are "pretty well standard" in a deal such as this, said Michael Focht Sr., NME's president and chief operating officer. He will remain president and COO of the merged company.
He and other NME executives argue that the merger savings will increase in years to come and that the deal bolsters NME's market clout in five regions-southern Florida, Southern California, Northern California, the central coast of California and New Orleans.
Market problems.However, two of those markets could pose problems. In the New Orleans area, AMI's only hospital, 149-bed AMI St. Jude Medical Center, is going on the auction block at the end of this month. AMI holds a 25-year lease to the hospital, which has been a longtime money-loser. The hospital building is owned by another company that has been foreclosed on, and AMI intends to bid for the hospital. Still, other bidders are expected.
For example, Columbia/HCA also is building a New Orleans-area network. Last week, Mr. Focht said he thought Columbia/HCA would have "very little motivation to take that one particular hospital."
Meanwhile, AMI and NME own hospitals in the San Luis Obispo, Calif.,area-another of the key markets. That is the only area where antitrust concerns may arise, NME executives said.
The transaction costs in the NME-AMI deal are higher than most of the recent large hospital mergers because AMI shareholders will be paid in cash and stock, rather than just stock. When Columbia Hospital Corp. merged with Galen Health Care and later with Hospital Corporation of America, and now in its proposed merger with Healthtrust, the deals were all stock swaps.
That minimized the financing costs. In addition, the deals were "pooling-of-interest" transactions that didn't have the tax consequences of the NME-AMI deal.
Because of AMI's ownership structure and the partial payment of cash, NME is taking on $2.3 billion in AMI goodwill. Goodwill is an accounting term that refers to the purchase price paid minus the value of the hard assets.
Goodwill is not a tax-deductible item, meaning that NME can expect to incur about $20 million in additional taxes each year for 40 years-the length of the amortization.
However, taxes aren't a particular problem for NME because of its huge fines and legal settlements stemming from its ill-fated psychiatric operations. For example, $314 million of the fine NME paid to government is tax-deductible. The bottom line is that NME won't have to pay any corporate federal taxes in 1995.
Motivated buyers, sellers.Despite the high costs associated with the deal, observers say both companies were motivated to move quickly.
Sources say AMI investors and executives were aware that Columbia/HCA's president and chief executive officer, Richard Scott, had been talking to NME about a possible acquisition. In addition, AMI and NME also had been talking for several months. Because AMI's controlling shareholders wanted at least part cash in exchange for their shares, those negotiations frequently centered on price.
"To the extent to which we are not going to be in control, our policy is to liquefy a significant part of the investment," said Melvyn Klein, an AMI director who helped lead the 1989 leveraged buyout of AMI. Mr. Klein is general partner of Chicago-based GKH investor group, whose stake in the newly merged company will be 5%, down from 32% in AMI. Three companies-GKH, First Boston Corp. and the pension fund of General Motors Corp.-own 60% of AMI. Their approval of last week's merger means AMI won't be required to file a proxy or hold a shareholder meeting.
In recent weeks, those controlling shareholders became concerned about recent events affecting the healthcare industry. For example, last spring, AMI stock topped out at $26.63 on the New York Stock Exchange, and some analysts said it could go as high as $30 because of takeover speculation.
It didn't, and by Oct. 7-a few days after Columbia/HCA announced its deal with Healthtrust-the stock was down to $22.50-15% off the peak.
Over the weekend of Oct. 8 and 9, a group of AMI directors and executives flew to Santa Monica to talk with NME Chairman and CEO Jeffrey Barbakow and his team.
Both sides were eager for a deal, sources said, because Columbia/HCA had just agreed to buy Healthtrust, and AMI officials realized that Columbia/HCA had the resources to buy cash-rich NME as well.
"Had Columbia bought NME, the cash value of AMI would have been substantially impaired," said Todd Richter, healthcare analyst for Dean Witter Reynolds, a New York-based investment banking firm. "There were no more cash buyers (for AMI)."
Willingness to do the deal may have gotten AMI shareholders more cash, too. Under a proposed deal that was leaked to The Wall Street Journal last month, AMI shareholders were to receive $15.50, half a share of NME and half an NME warrant for each share they held.
Under last week's agreement, AMI shareholders will receive $19 in cash and 0.42 share of NME stock for each share they hold.
Robert O'Leary, AMI's chairman and CEO, and John Casey, president and COO, will become co-vice chairmen of the new company. Their operating roles haven't been determined.