Questions are increasing about whether Columbia/HCA Healthcare Corp. is paying enough for Blue Cross and Blue Shield of Ohio as details and analyses of the complex transaction emerge.
This week, Blue Cross policyholders will ask a Cuyahoga County Court judge in Cleveland for a preliminary injunction so that an independent valuation of the deal may be done.
That move is likely to heighten scrutiny of the deal, although documents filed with the state of Ohio disclose that it would be very expensive for the Blues to kill the agreement.
Although critics contend Columbia is getting a bargain, Columbia has little incentive to enhance its offer. "I don't think that's being considered," said Columbia spokesman Jeff Prescott, adding that the company has a definitive agreement that may preclude other bidders from turning the sale into an auction.
Columbia, the Nashville, Tenn.-based chain of 340 hospitals, agreed in April to pay $299.5 million for most of the Blues plan. The Blues is Ohio's largest insurer, a not-for-profit organization that would be converted to for-profit status as a result of the transaction.
Blues policyholders, backed by the Consumer Federation of America in Washington, have sued in Cuyahoga County Court to stop the deal, saying that Columbia is not paying enough.
Despite rumors in recent weeks that other bidders may come forward to vie for the Blues, sources close to the transaction said last week that those offers have not materialized.
Indeed, the Blues has little motivation to get a higher price for the company and much to lose if it accepts a higher bid.
In documents filed with the state and obtained by MODERN HEALTHCARE, Blues officials disclosed that if they back out of the deal, they would have to pay Columbia a $25 million fee.
Known as a breakup fee, such penalties are common in mergers and acquisitions. Each of Columbia's merger agreements with hospital chains has included a breakup fee clause.
However, the breakup fee in the Ohio Blues deal has an extra catch.
If the Blues backs out, it would have to enter five-year provider contracts with all of Columbia's hospitals and outpatient centers in Ohio and West Virginia at premium reimbursement rates. The document, filed with the Ohio Department of Insurance, says those rates must be "equal to or greater than the highest rates" charged "by any hospitals or outpatient centers" in those states.
Even if Columbia calls off the deal, the financial penalties would still weigh on the Blues. According to the documents, Columbia still could receive the termination fee and the reimbursement contracts if the Blues accepts another offer equal to or greater than Columbia's within a year of the termination. If the Blues accepts an offer that's less than Columbia's, the healthcare giant still gets right of first refusal at the lower price for one year.
Meanwhile, controversy surrounds the price of the Blues-Columbia transaction.
At the crux of the debate are the Blues' cash reserves, which its officials say amount to $233 million. However, in their suit, the policyholders and the Consumer Federation of America contend the amount is closer to $302 million. Attorneys for the plaintiffs said the two sides are using different accounting methods.
Critics, including the plaintiffs, say Columbia is paying $299.5 million, but would receive $233 million in cash reserves as part of the deal. In essence, they say, Columbia is only paying about $70 million for the business.
"I think it's fallacious to say they're buying it for $70 million," countered J.B. Silvers, health industry analyst for Case Western Reserve University's Weatherhead School of Management in Cleveland.
"You can't run an insurance company without reserves," he said, noting that the reserves are the equivalent of buying the equipment in a factory as part of the purchase of a manufacturing business.
However, Silvers did say that the issue of whether the Blues is overfunded is a legitimate one. If it is, Columbia could simply appropriate some of the cash, thereby lowering the effective purchase price by that amount, he said.
Essentially, the deal is a two-step transaction (See chart). Columbia will pay $299.5 million to the Blues. The amount equals the insurer's book value for its assets.
Whether book value is a valid price determination for the insurer is debatable. In some cases, managed-care mergers are valued on a per-enrollee basis. In others, they're measured on a discounted cash flow, which is common in other types of business transactions.
According to a chart compiled by Donaldson, Lufkin & Jenrette, a New York-based investment banking firm, Columbia is paying much less on a per-enrollee basis than other managed-care plans have paid.
The analysis of 15 managed-care transactions shows that businesses with a mix of managed-care enrollees and indemnity subscribers were purchased for between $506 and $928 per enrollee during the past two years. In contrast, Columbia is buying the Ohio Blues for about $200 per enrollee.
Dean Witter, another New York-based investment bank, was retained by the Blues to analyze the transaction and issue a fairness opinion. However, that document has not yet been released.
The Blues will transfer its insurance business stock and its reserves to a new corporation called BlueCo.
Blue Cross and Blue Shield will continue to exist, but not as a health insurance company. It will have the $299.5 million from Columbia, and will become a reinsurance agent for BlueCo.
By reinsuring the business of BlueCo, Columbia will hedge its downside risk. The reinsurance would cover losses if the Columbia-controlled insurer lets its medical-loss ratio rise above 88.5%. Columbia won't get the reinsurance for free, though. It will pay a fee of 0.58% of total premiums.
That would cover the new insurer for up to $30 million in losses annually for five years.
If the deal is completed, the Ohio plan would be the third Blues plan to convert to a for-profit company. Last month, Blue Cross of California completed its conversion. As part of its metamorphosis, the plan was forced to donate $3.3 billion in assets to charities.
Also last month, Blue Cross and Blue Shield of Georgia filed a registration with the Securities and Exchange Commission to issue 800,000 shares of convertible stock to its 160,000 subscribers. The shares will convert to publicly held stock if the company undertakes a public offering.
The Georgia Blues, which provides coverage to 1.4 million individuals, converted to a for-profit company in February and formed Cerulean Cos. as a holding company for the Blues business in the state.
The Georgia Blues is distributing its stock free to subscribers, making a value comparison with the Ohio Blues problematic.