A $200 million commitment from PhyCor's largest stockholder appears to have given the physician practice manager a major confidence boost. This comes after a year of trouble, including stock price declines, rebelling clinics and general malaise in the PPM industry.
"It closes the question as to whether PhyCor is going to be around or not," declares Joseph Hutts, the Nashville, Tenn.-based company's chairman and chief executive officer.
At the very least, the commitment from E.M. Warburg, Pincus & Co. buys PhyCor some time to pay off its debts and improve its operations, which have suffered multiple value writedowns. It also gives PhyCor an endorsement on Wall Street from a trusted brand name.
The $200 million commitment from Warburg Pincus has two parts: a $127.5 million purchase of zero-coupon notes, convertible into stock, and a $72.5 million purchase of PhyCor stock. The investment allows the New York investment firm two spots on PhyCor's board, expanding it to 13 members from 11.
PhyCor's future health may determine whether the notes portion of the deal is an investment or the equivalent of paying off credit-card debt by transferring it to another card. "This was not meant to be debt," Hutts says. "This was meant to be very much convertible equity."
At the beginning of this year, PhyCor was at its peak with about 3,700 physicians in 60 clinics. As of June 15, the company was down to 52 clinics with 3,360 physicians. PhyCor's total of 24,000 doctors in independent practice associations in 36 markets has been stable throughout the year.
Warburg Pincus declared its enthusiasm for PhyCor's future in a June 15 news release announcing its commitment. At the very least, the deal will put Warburg Pincus closer to the front of the collection line if PhyCor stumbles. That's because bondholders rank behind bank lenders and ahead of common stockholders -- who usually get nothing -- in dividing the assets of a company in Chapter 11 reorganization.
The stock purchase is the least complicated part of the deal. Within six months of the deal's close, which Hutts thinks will happen sometime in August, Warburg Pincus will buy PhyCor shares on the open market.
According to terms of the deal outlined in a June 17 Securities and Exchange Commission filing, that $72.5 million can't buy more than 15 million shares, but it can certainly buy less. Warburg Pincus controls about 7.6 million of PhyCor's 76.2 million shares. Buying 15 million shares on the open market would give Warburg Pincus a 30% stake in PhyCor.
On June 16 -- the first day of trading after the Warburg Pincus announcement -- PhyCor's stock closed up 24% to $7.72. Since January, its stock has had a pattern of climbing to about $8, then falling to $4, then jumping up again.
Hutts admits that a short-term drop in PhyCor's stock price may be in Warburg Pincus' best interest because the firm would get more shares. Warburg Pincus bought its previous 7.6 million shares for an average price of $5.71, according to SEC documents. So at $7.72 per share, its investment is already up about 25%.
While Warburg Pincus' stock purchases could raise the price of PhyCor stock by taking more off the market, it's the bond issue that will actually give the company some cash.
Under the zero-coupon portion of the deal, PhyCor gets $127.5 million upfront by selling bonds with an 8% annual yield and a 15-year maturity. Unlike other bonds, zero-coupon notes allow the seller to delay interest payments until maturity. That way, PhyCor can spend the 8% on other things in the interim. Once the bond matures, the money is due in full. The grand total of principal and interest, according to PhyCor's June 17 SEC filing, is $404 million.
PhyCor could end up paying that principal in less than 15 years. The deal includes what's called a "put option" after 10 years. That means Warburg Pincus has the option in 2009 to ask PhyCor to redeem the bonds.
The bonds at their maturity convert into 15.2 million shares of stock. At $127.5 million, that's $8.38 per share. However, at $404 million, that's $26.58 per share, which sounds heady for a company whose stock hasn't seen double digits since July 1998.
But Hutts figures PhyCor can boost its stock price to that level in the next 10 to 15 years. First, it plans to use $27.5 million of the proceeds to buy back stock, part of a previously announced plan to repurchase $75 million in shares.
Then, with the remaining $100 million, PhyCor plans to pay off a portion of its $400 million in bank debt, says Chief Financial Officer John Crawford.
Meanwhile, Hutts is talking about acquiring more practices and IPAs. He says deals are under discussion, but he wouldn't give any details.
