Forstmann Little & Co.'s first healthcare endeavor is off to a satisfying start.
Just seven months after the New York buyout firm acquired Brentwood, Tenn.-based Community Health Systems for $1.4 billion, Community's managers, who have retained key operational roles in the company, and the new owner have increased the number of hospitals they plan to acquire.
"We plan on doubling the size of the company," said Sandra Horbach, general partner at Forstmann Little. "We're actually ahead of the plan, but our mandate is to make smart acquisitions. The ongoing business and strategy hasn't changed."
Forstmann Little appears confident in its ability to pull off those goals, viewing rural and nonurban hospital acquisitions as fertile ground for years to come.
Since Forstmann Little purchased Community last July, the hospital chain has acquired seven facilities. It now has 40 primarily rural and nonurban hospitals in 16 states.
With expectations to have between 75 and 80 hospitals five years from now, Community also would more than double the number of acquisitions it and its top competitors make each year in the nonurban and rural hospital markets.
Firms like Health Management Associates of Naples, Fla., and Quorum Health Group, of Brentwood, typically acquire two to four hospitals a year. Community had been on a similar pace in its first 12 years.
Forstmann Little's acquisition gave Community shareholders a 20% premium on their stock when it acquired Community. The transaction made Community a privately held company.
"Not only is it our first foray into healthcare, but it's also the single largest single investment on behalf of our partners in any one single investment to date," Horbach said.
Forstmann Little's purchase of Community remains as one of few all-cash purchases of a hospital chain this past decade.
The firm agreed to invest $1 billion of its own capital -$500 million in equity and $500 million in subordinated debt-in buying Community.
In addition, Chase Manhattan Corp. has supplied $900 million in bank financing that paid for the balance of the acquisition of Community and provided more than $100 million for acquisitions made thus far, Horbach said.
That leaves about $500 million from the credit line for additional hospital acquisitions, Horbach said.
"If we have the opportunity to spend the $500 million in two years, we will do so," Horbach said, "but we want to be smart about our acquisitions. We want to be able absorb them into the system."
As a publicly traded company, Community was spending about $100 million a year on acquisitions, the chain's executives said.
"The (new deal) gives us about five years of gunpowder right away," said Thomas Chaney, Community's chief executive officer. "If we would've stayed public, we would have (grown) in increments. Forstmann Little has pre-funded our acquisitions for five years."
Chaney, who co-founded Community with current company Chairman Richard Ragsdale, decided early last year he didn't want to manage the company on a daily basis. Wayne T. Smith, who was hired last month, succeeded Chaney as Community's president (Jan. 20. p. 16).
Ragsdale said there were some who chuckled at what Forstmann Little paid for Community, which investment bankers shopped to about 20 other possible buyers.
But the deal's naysayers apparently don't know much about the buyout firm. The company's founder, Ted Forstmann, is a Wall Street legend, and his buyout funds are similar to mutual funds except they buy companies instead of stocks and bonds.
"There are a lot of people on (Wall Street) who thought he paid too much, but he's averaged about 60% equity return on his investments," Ragsdale said of Ted Forstmann.
During the 18-year history of Forstmann Little's subordinated debt and equity partnerships, the firm has made impressive returns (See chart).
In its subordinated debt partnerships, Forstmann Little has invested $4.6 billion and has produced $8.1 billion, a compound annual return of 20% from 1978 to 1996. Meanwhile, its equity partnerships have produced nearly $3 billion from equity investments of $800 million for a compound annual return of 57%.
According to published reports, Forstmann Little is amassing a war chest of up to
$4 billion in equity and subordinated debt to fund future dealmaking.
Forstmann Little doesn't figure to be disappointed with Community. In 1996, the chain had more than $700 million in annual revenues, an increase of nearly 30% compared with 1995.
In 1995, Community's last full year as a publicly traded company, net income totaled $21.6 million, up 174% from 1994. Community posted operating revenues of $563 million, up 20% from 1994.
As a private company, Community doesn't release its earnings figures or related financial information. However, Horbach indicated Community's profits were above par last year. "You could say earnings were up significantly (in 1996)," she said.
"Community shares a lot of the same characteristics as the other companies we acquire," Horbach added. "It has strong management, dominates its markets, and there is a real need for the services and products it provides. Community has had an excellent track record."
Community will continue to pursue acquisitions in communities with populations of 20,000 to 80,000. The company is the sole or dominant provider in 95% of its markets. That lack of competition and less-prevalent managed care helps make these smaller markets attractive.
Forstmann Little doesn't have plans to acquire additional hospital companies, but it isn't ruling out the possibility.
"We are in the business of acquiring companies. We will look at opportunities, but we don't have a mandate to buy healthcare companies," Horbach said.