During the 1980s, employee stock ownership plans were burning up the healthcare finance scene.
HCA-Hospital Corporation of America sold its rural hospitals to an ESOP named Healthtrust in 1987 and wanted to sell its psychiatric hospitals to an ESOP as well. Although the latter deal fell through, ESOPs kept rolling along.
In 1988, American Medical International sold its rural hospitals to an ESOP named Epic Healthcare Group, and psychiatric hospital chain Charter Medical Corp. completed a leveraged buyout using ESOP financing. Republic Health Corp. followed by selling half of its crown jewel, Houston Northwest Medical Center, to an ESOP to raise cash when it was struggling.
Now it's 1995, and the only hospital ESOP remaining from the '80s boom is Houston Northwest. However, even its future status as an ESOP is questionable since the hospital is for sale.
But observers say it might be time for an ESOP resurgence.
A Missouri ESOP.Employees of
Doctors Regional Medical Center in Poplar Bluff, Mo., recently bought 33% of the 185-bed hospital through an ESOP.
Workers at the hospital had never thought about buying the hospital until Chief Financial Officer Jack Montois came up with the idea.
"I talked them into it," he said unabashedly.
Poplar Bluff is a town of about 20,000, equidistant from St. Louis and Memphis, Tenn. Doctors Regional competes with an AMI facility, 165-bed AMI Lucy Lee Hospital, also in Poplar Bluff.
AMI officials had been talking to the physicians who own Doctors Regional, and Montois didn't like the implications of that. "My biggest fear was that they were going to buy the hospital, shut it down and put 600 people out of work," he said.
Montois did some studying and found ESOPs. "I don't know why ESOPs have waned," he said. "They're a tremendous way of financing."
ESOPs are company-provided retirement plans in which the assets are invested primarily in company stock. Unlike some retirement plans, an ESOP is funded entirely by the company, which in this case is the hospital. Employees are issued stock and depend on appreciation of the shares to fund their retirement benefits.
Even on the small scale of Poplar Bluff, the underlying rationale for ESOPs is the same: They give employees a stake in the financial operations of the hospital. What's more, they give a company-or hospital-a way to prevent a takeover at minimal cost. For example, the sale of stock to employees allows companies to avoid the substantial fees involved in other acquisition defenses. Another financial advantage is that the company can pay back the ESOP loan with pre-tax dollars.
"It worked out very well," said Ken Serwinski, senior vice president of business advisory services at Merrill Lynch in Chicago. The firm worked on the deal with Doctors Regional and its owners.
Serwinksi said he believes ESOPs fell out of favor because "it became a lot easier to sell the businesses outright than to do it through an ESOP." Also, conventional financing was easy to obtain, he said. Most of the merger and acquisition activity recently has been financed through traditional channels such as stock swaps, cash or bond deals.
However, Serwinski said he's been getting some phone calls from hospital executives interested in pursuing an ESOP. "Rather than sell outright, it's a way to keep (a hospital) in the family," he said.
Buying a hospital.
As the name describes, Doctors Regional was owned by physicians who had purchased the facility in 1990 for $20.6 million from then debt-laden Hallmark Healthcare Corp. Hallmark has since been acquired by Houston-based Community Health Systems. Doctors Regional was profitable and continues to be so (See chart).
To buy the hospital, about 30 physicians and dentists put up a total of $1 million and borrowed the remainder.
Since owning a hospital isn't a highly liquid investment, the ESOP gave the doctors a way to get some cash back after four years.
A valuation of the hospital in 1994 found it had increased in worth to $26 million. The ESOP borrowed $9 million from a bank to buy its 33% share. Half of the $9 million went to Hallmark, which held some stock appreciation rights that had to be repaid, and the other half went to the physicians.
Because of the ESOP, the physicians' equity stake dropped to 67%. However, their $4.5 million was a pretty good return on the $1 million they put up to buy the hospital in 1990.
In addition, since more than 30% of the hospital was sold to an ESOP, the physicians can defer capital gains taxes on their investment proceeds as long as they roll them over into other investments such as stocks and bonds, Serwinski said.
Montois calls the ESOP a "win-win for everybody," including hospital employees, whom he believes will "take a little more interest in what goes on here."