Healthcare stock analysts were floored by the strong earnings Triad Hospitals posted for the first three months of 2002. The Dallas-based chain earned 55 cents per share for the quarter, compared with analysts' consensus estimate of 39 cents per share.
"Wow!" began a report on the quarter written by Lehman Bros. analyst Adam Feinstein. "Making a quantum leap" was the headline on a report from Rob Mains, a healthcare stock analyst with the brokerage firm Advest, Hartford, Conn.
Triad's first-quarter earnings report was released April 24, nearly a year to the day that Triad completed its $2.4 billion acquisition of Quorum Health Group, Brentwood, Tenn. Triad earned net income of $40.4 million on revenue of $860.9 million (April 29, p. 14). Analysts saw the earnings results as a sign that Triad had turned the corner, that it had finished integrating Quorum's hospitals and now was making them hum. Many analysts had seen the acquisition as risky, not because they didn't like Triad's management, but because the deal doubled the size of a company that had barely existed for two years after its May 1999 spinoff from Nashville-based HCA. They believed the Quorum hospitals had been underperforming, and they wondered whether Triad had paid too much for financially strapped Quorum.
Denny Shelton, Triad's chairman and chief executive officer, was not surprised by the earnings. He had seen a quarter like this coming. In an exclusive interview on the first anniversary of the acquisition's closing, April 27, 2001, Shelton told Modern Healthcare: "I knew that when we did the deal. I had been in the hospitals repeatedly. I had a high degree of comfort. Once we started getting our cornerstone pieces into place, and once it was accepted by the communities, through the fall, I knew we would do well."
Though Shelton was confident, it took the first-quarter results to put to rest some doubts about the deal for those outside the company. The size of the deal-adding Quorum's 22 hospitals to the 31 that Triad owned-was part of the uncertainty. (Thanks to sales and a closure, Triad now owns or operates 46 hospitals.) In February, when Triad announced that its 2001 earnings fell 36% to $2.8 million, or 5 cents per share, compared with 2000, analysts peppered Shelton and other Triad executives with questions for more than two hours. The analysts remained positive about the company, but many of the questions they had were the same that had lingered since the Triad-Quorum deal was announced in October 2000.
"At the time that the Quorum acquisition was completed, the Quorum assets were not experiencing any same-store admissions growth; in fact, the same-store trend was negative," says Lori Price, an analyst with JPMorgan Chase. "There was some concern that Triad may have bought problematic assets or assets in mature markets. Could they turn these around?"
Analysts believed that Quorum had been underinvesting in its hospitals in the 18 months leading up to the sale, Price adds. Management seemed distracted by negotiations with the federal government to resolve a civil whistleblower lawsuit that alleged Medicare cost-reporting fraud, she says. Those talks started in March 1999 and resulted in a settlement, announced just before the deal with Triad was made public, that eventually amounted to $100.5 million.
The results for 2001 still left some questions for Price. In particular, she was concerned that the Quorum hospitals had boosted their revenue, but the ratio of labor cost to revenue for the combined Triad was 42.4%, whereas in 2000, the preacquisition Triad had a 41% ratio. When that ratio dropped in the first quarter to 41.1% for the combined company, Price was reassured that Triad was increasing not only revenue but operating margins.
"This is hard-earned vindication, but I think they have justified the merger" so far, Price says.
Gary Taylor, an analyst with Banc of America Securities, says the Quorum hospitals also had weak operating margins and managed-care reimbursements when the acquisition was announced. At the same time, Taylor says, he believed that Quorum's broader geographical reach across the Southeast and Midwest would balance Triad's concentration in the Southwest.
"Personally, I saw the acquisition and said, 'Strategically, this makes sense to me. Yeah, I wish they could've bought it a little cheaper, but valuations are what they are,' " Taylor recalls.
Taylor also notes that most analysts worry about how a company will integrate an acquisition that doubles the size of the company, in any industry. Massive computer systems that handle both financial and clinical data must work together, for example. A specific integration risk with hospital acquisitions is the reaction of physicians, Taylor says. "Some of these Quorum physicians had had two or three owners over the last eight years or so," switching, for example, from Quorum management under local, not-for-profit ownership to Quorum ownership, and then to Triad ownership, he says. "The risk is that they take their business down the street to the local not-for-profit. You lose that volume, and that's a real risk."
But physician relationships are a central part of Triad's operating strategy, Taylor adds. "Here's a huge risk that everybody's worried about, and here's a management team that puts a big emphasis on that," he says. "Their existing strategies seemed to address the risks."
Listening and talking
Executives and physicians who were part of Quorum and have made the switch say they see a lot of similarities between the two companies, especially in the cultural attitudes that healthcare is a local service and that doing right by patients is also the best business strategy.
But they also say that Triad has provided more structure, has organized better many financial and nonclinical operations, and has forced hospital CEOs to do a better job of capital planning.
Gaines Hammond, M.D., has seen the effects of ownership transitions at 212-bed Mary Black Health System, Spartanburg, S.C. Hammond practiced there when it was a not-for-profit hospital, stayed on when Quorum bought the hospital in the mid-1990s and has remained through Triad's acquisition. Hammond says he had heard nothing but good things about Shelton and Triad from colleagues around the state and in Arkansas, Louisiana and Texas. "We doctors had checked on his relationships with physicians, and we knew he was the real McCoy," Hammond says.
Quorum had done a good job of communicating with physicians, but Triad has taken that a step further with its physician leadership group at each hospital, Hammond adds. "It's pretty nice to be able to pick up the telephone and call somebody at corporate and have them know who you are," he says. "This is more physician-focused than it was before. I've seen a lot of companies where they go through a merger or acquisitions, and they go through a lot of adjustments, but I didn't really see that with Triad. These guys really know what they're doing."
Michael Schatzlein, M.D., also has seen the transitions. Now the CEO of Triad's 86-bed Dupont Hospital, Fort Wayne, Ind., Schatzlein was a cardiovascular surgeon in Fort Wayne from 1980 to 1994, and has worked as an executive in several of the hospitals that form the local six-hospital Lutheran Health Network that Quorum purchased in 1995.
Triad brings a strong operating discipline to its hospitals without strangling local managers, Schatzlein says, citing the physician groups and Triad's insistence that the groups meet monthly. Schatzlein also sees greater discipline in the approach to meeting the standards of the Joint Commission on Accreditation of Healthcare Organizations. Instead of gearing up only in advance of the once-in-three-years visits by the JCAHO, Triad employs a more continual method, he says.
Greater discipline has been brought to bear on financial reports, too, he says, with more statistics being kept, and more of them available in a real-time basis across the company, he says. "To me, that's helpful," he adds, "because if some guy in Hope, Ark., is beating me in terms of some statistic, then I can call him up and figure out how he's doing it."
Bill Anderson switched from a regional president's job with Quorum to a similar job as a division president with Triad. He oversees 11 hospitals, nine of which were part of Quorum, in Indiana, Kentucky and Ohio, and he sees the advantages of a more common approach to surveying employee, patient and physician satisfaction. Triad uses one company to conduct the surveys at all of its facilities, so the scores from different facilities can be more readily compared, Anderson says, adding, "Quorum was more mix and match."
For 11 years, Jim McKenzie, M.D., has been an orthopedic surgeon at Northwest Health System, which includes hospitals in Bentonville and Springdale, Ark. Triad is building a replacement for the Bentonville hospital. He cites Triad's greater ability to invest money in its hospitals as the biggest change from Quorum.
"We are (about) six months into construction of a new hospital, a 128-bed facility which about triples our current capacity," McKenzie says. "When we were just with Quorum, we were going to do a replacement facility, about an $18 million to $20 million project, and now we're into a $60 million project." Once the Triad managers got a better grasp of marketing and patient data, they were enthusiastic about expanding the project, which now includes enough land to build a second 128-bed patient tower, McKenzie says.
Shelton says it wasn't too hard to see that the new hospital had to be bigger. "We had a contractual obligation to build a replacement hospital and were going to do 35 to 40 beds. Well, the day I visited there, they had 38 patients in the hospital," he says. "It's the fastest-growing community in Arkansas and has a lot of retirement growth."
Triad also boosted the size of the new hospital project it inherited in Vicksburg, Miss., which consolidated acute-care services at a new, larger hospital, Shelton says. The company added 60 beds to the initial plan for 178 beds, added two cardiac catheterization laboratories to the one that was planned and added a second room to handle Caesarean sections, he says.
Quorum's precarious finances had shut off the flow of debt capital that it could raise, and as a result, it "had downsized some projects," Shelton says.
One thing on which the physicians and executives who made the switch from Quorum to Triad agree is that the Medicare cost-reporting fraud case against Quorum took a huge toll on Quorum's senior management. "Anything of that magnitude, there's no question that that takes resources and is very distracting, for any corporation," says Anderson, the division president. "That caused distraction, and there's only so many hours in the day sometimes."
When the acquisition was announced, Triad said it wanted to sell Quorum's management subsidiary, Quorum Health Resources. But after Triad solicited bids, Shelton says, it became clear that the more than 200 hospitals that QHR manages could fuel future acquisitions. Already, Triad is in exclusive negotiations to lease 199-bed Fairmont (W.Va.) General Hospital as a precursor to building and owning a $75 million replacement hospital in Fairmont, as announced last month by the Fairmont board and confirmed by Shelton.
Overall, Shelton sees the company completing three to five acquisitions or joint ventures annually. Triad has "four conversations going on with larger not-for-profit systems in urban markets on building a hospital or ambulatory surgery center together," he says. Triad's goal, he adds, is to be the capital partner of choice for not-for-profit hospitals, whether in outright acquisitions or ventures.
Another key is to keep the culture of Triad as it grows. Shelton wants to maintain the hospital divisions, which now number five, at a size of seven to 10 hospitals, even as Triad adds to its stable of 46 hospitals that are owned or operated. Triad also has an ambulatory surgery division that oversees 14 centers and the QHR division. At the corporate level, Triad wants to add an investor relations executive to take pressure off Chief Financial Officer Burke Whitman, Shelton says. In another move that recognizes the growth of Triad, Dan Moen, the CEO of QHR, recently added the title of executive vice president of development to take the acquisition load off Shelton, Shelton says.
Overall, the key is to "stay disciplined, stay true to culturally what you believe," Shelton says. At a recent leadership meeting that included corporate executives, hospital CEOs and physician leaders, "I told all of the teams that's one of my big concerns," he adds. "Everybody says, 'Wow, look how great we've done.' I worry about complacency and not moving the ball forward.
"The only thing that could keep us from being a great company is ourselves, losing our focus and our commitment."
Healthcare stock analysts see a lot of growth opportunities for Triad with its existing hospitals. JPMorgan's Price says the company needs to continue to invest capital "in a targeted way that produces attractive same-store admissions and revenue trends, which are leveraged over other (fixed) expenses and boost margins. Consistent, predictable returns-regardless of who you are, that's something that investors are going to demand."
Banc of America's Taylor sees Triad in much the same light. "They have plenty of opportunities with what they bought a year ago with Quorum to continue to grow (their earnings) 25% a year," he says.
Ultimately, the key measure of the Quorum acquisition will be the returns on invested capital, Taylor says. Besides its greater size, return on capital is what has separated HCA and Tenet Healthcare Corp., Santa Barbara, Calif., from the rest of the for-profit hospital pack.
Five years from now, Taylor says, the questions that should be asked are: "What are the returns on invested capital? Was it a good acquisition based on the price they paid?"