When Sierra Health Services said last week it was acquiring Physician Corporation of America, it saw the deal as a diamond in the rough. Wall Street initially saw it as a rock around Sierra's neck.
"Merger synergies are few, the transaction is materially diluting to Sierra, and we do not believe the combination of the two companies will accelerate the slow improvement in profitability occurring within (PCA)," said analyst Ed Keaney with Volpe Welty Co.
Keaney didn't issue a downgrade of Sierra's stock, but several other analysts did. Sierra's stock closed at $23.88 per share on Nov. 4, the day of the announcement. That was down $5 per share from the previous close.
Sierra, a Las Vegas-based managed-care company, intends to acquire PCA, a Miami-based managed-care company, in a tax-free stock swap initially valued at $509 million.
The deal, which is expected to close by next March, would create the country's eighth-largest publicly traded managed-care company, with more than $2 billion in revenues, operations in 18 states and Puerto Rico, and 1.5 million enrollees.
Initial concerns of financial analysts center around synergies between Sierra and PCA, or the perceived lack of them. The companies' operations overlap only in Houston.
Anthony M. Marlon, M.D., Sierra's chairman and chief executive officer, dismissed the assessment.
"They're really obsessed about the lack of geographical overlap," he said. "But the issue here is assets. You match our management skill set with their assets and you will end up with superbly managed assets that will benefit the shareholders. To suggest that the only way to make a deal like this worthwhile is to lay people off is absurd. I don't buy into that."
Another, more obvious concern is money. Sierra has been profitable, but PCA has struggled to stay in the black.
PCA lost $95 million through the third quarter ended Sept. 30. Much of that is attributable to a $130 million write-off associated with its workers' compensation business. Through the third quarter of the previous fiscal year, PCA had posted an $11.9 million profit.
Sierra reported a 58% drop in net income for the third quarter to $4.1 million, or 23 cents per share, from $9.7 million, or 56 cents per share, in the year-ago quarter. Revenues rose 21% to $97.5 million. Those figures included a $6.2 million restructuring charge, or 35 cents per share, to consolidate certain operations in Arizona, California and Colorado.
For the nine months, Sierra's net income rose 18% to $24.4 million, or $1.38 per share, from $20.6 million, or $1.19 per share, in the year-ago quarter. Revenues rose 20% to $281.5 million.
Marlon vowed to shave $15 million off the combined companies' operating expenses in part by cutting PCA's claims-processing costs and reducing its medical-loss ratio, which has ballooned nearly five percentage points from a year ago. The ratio measures how much the company spends on medical care for every dollar in premiums it takes in.
"Our MLRs run at 76% to 77%, while PCA is in the high 80s. By the end of next year, we'll be 80% to 81% across the board," he vowed.
Marlon also waved off concerns that the deal would depress Sierra's long-term bottom line. In fact, he blamed that scare squarely on himself.
"I unfortunately conveyed that notion to the analysts. It will actually start being accretive by the fourth quarter of 1997 and going forward in 1998," he said.
Marlon predicted that Sierra would reach its projected net income of $2.70 per share by the end of 1997 and that the deal would add another 20% to Sierra's initial 1998 projections of $3.10 to $3.15 per share.
After Marlon repeated that information to analysts during a conference call on Nov. 6, Sierra's shares rose to $27.13 per share, wiping out much of the initial loss. Now the naysayers are considering a second look.
"I'm kind of a little bit on the fence now," said James Lane with Dillon Read & Co., who had downgraded Sierra on the day the deal was announced. "Some of the information I had received earlier was inconsistent with what came later. . . but now I'm a little bit more positively disposed."
Lane added that he called Sierra for a face-to-face meeting with Marlon and its other upper management.
"I still want a personal conversation and walk through the numbers with them," he said.
Once the merger is completed, the Sierra name will be retained, along with its Las Vegas headquarters. Stanley Kardatzke, M.D., PCA's chairman and CEO, will become Sierra's chairman, while Marlon will remain CEO and become vice chair.
Marlon said the company's initial focus will be on Florida, which is PCA's largest state, with 342,000 enrollees, and also is the one where it is encountering the most difficulties. PCA's other large pools of enrollees are in Puerto Rico, with 300,000, and in Texas, where the companies' combined enrollment is 276,000. Most of Sierra's business comes from Nevada, where it has 147,000 enrollees.
Marlon said there were no immediate plans to use the Texas and Florida enrollment as a springboard into the Southeast, where managed-care penetration is low.