Investment bankers shopped Community Health Systems to 20 possible buyers earlier this year after the hospital chain's chief executive officer told his board he didn't want to manage the company on a day-to-day basis anymore.
Those details were revealed last week in a filing with the Securities and Exchange Commission as part of CHS' agreement to be sold for $1.4 billion to the investment firm Forstmann Little & Co.
The transaction, which gave shareholders a 20% premium on their stock, is one of the few all-cash purchases of a hospital chain in the past decade. After the purchase is completed, the Brentwood, Tenn.-based chain of 38 rural and suburban hospitals in 18 states will be a privately held company.
At $52 per share, the sale would be a windfall for CHS shareholders, who include Chairman Richard Ragsdale, 52, and President and CEO E. Thomas Chaney, 53. Both are co-founders of the company.
CHS stock surged $8.50 to close at $51.88 in New York Stock Exchange trading June 10, the day the deal was announced.
When the deal was made public, it was heralded as increasing evidence of the financial attractiveness of rural healthcare companies. Indeed, New York-based Forstmann Little will invest $1 billion of its own capital, and Chase Manhattan will supply $900 million to buy CHS and help it acquire more hospitals.
However, SEC documents indicate the sale was prompted by a leadership dilemma at the growing hospital chain. In late 1995, Chaney decided he wanted to relinquish day-to-day management of the rural hospital chain and "function in a nonexecutive role," the document said. It also said he wanted to do so "in the near future," although a specific time is not given in the document.
The board began a search for his replacement but apparently didn't think it could find a new CEO as soon as Chaney wanted out of his current responsibilities. In March, the board hired Merrill Lynch, a New York-based investment banking firm, to analyze "strategic alternatives."
Merrill Lynch talked with more than 20 "strategic and financial parties" and signed confidentiality agreements with several, including Forstmann Little. The identities of the other possible buyers were not disclosed.
"They showed it to me," Richard Scott, Columbia/HCA Healthcare Corp.'s chairman, CEO and president, said last week of the CHS deal. Scott, in Dallas for the groundbreaking of a new hospital, declined to say whether the company made a bid on CHS.
On June 3, Forstmann Little proposed acquiring 20% of the company in newly issued shares at $50.50 per share. On June 5, Forstmann Little insisted CHS stop talking with other possible buyers and said it would raise its offer in exchange for an exclusive arrangement. CHS agreed, and Forstmann Little upped its offer to $52 per share.
On June 10, Merrill Lynch received $2 million for facilitating the deal with Forstmann Little. If it's completed, Merrill Lynch will receive a total of $9.1 million plus expenses, according to the SEC document.
Merrill Lynch won't be the only wealthy participant. CHS is being sold at a high multiple of earnings compared with other hospital stocks (See chart). "We are much closer to the peak in these assets," said Jeff Villwock, healthcare analyst for Johnson Rice & Co., a New Orleans-based investment bank.
At the buyout price, Chaney's stock is worth $14.1 million and Ragsdale's is worth $25.2 million. Neither executive has signed a contract with Forstmann Little, but both said last week they anticipated an agreement.
In addition, "Forstmann's practice is to offer equity interest" to management, Ragsdale said.
The SEC document disclosed pacts with two executive vice presidents, Tyree Wilburn and Ernest Bacon. Bacon left Columbia last month to join CHS.
It also details a consulting agreement with David Steffy, a co-founder and director of CHS until last year. Under the agreement, signed in May, Steffy would receive $750,000 a year, which is more than Chaney's annual salary. In addition, he will receive another $750,000 when CHS is sold.
Forstmann Little is expected to demand a substantial return on its investment. According to news reports, the private investment firm has more than $12 billion invested in 20 acquisitions and has generated average annual returns of about 60% on its equity investments.
Earlier this year, the firm raised $2.3 billion to create its largest buyout fund to date, which executives said may be the largest buyout fund raised in the 1990s.
The company's founder, Ted Forstmann, 56, is a legend on Wall Street for his warnings in the 1980s about the pitfalls of junk-bond financing. His buyout funds are like mutual funds, except that they buy companies instead of stocks and bonds.
This would be his first foray into healthcare. In 1995, Forstmann sold Ziff-Davis Publishing, the producer of PC Magazine, for $2.1 billion, a 50% return on the price he paid for it just a year earlier.
In a prepared statement, Forstmann called CHS a "superb company," noting its domination in small towns where it is either the only hospital or one of two.