Select Medical Corp. won't have to worry about stockholder scrutiny as it deals with changes in reimbursements to one of its major revenue streams.
With looming CMS-directed changes to admission policies at many of its long-term acute-care hospitals, Select Medical, which operates 83 such facilities, said last week that it will go private as part of a buyout deal valued at $2.3 billion. The Mechanicsburg, Pa.-based company will become a fully owned subsidiary of EGL Holding Co., a new company formed by the private equity firm Welsh, Carson, Anderson & Stowe.
The deal must be approved by a majority of stockholders and is expected to close in the first quarter of 2005. Morningstar, an investment research firm, said shareholders would be wise to take the $18-per-share price because it exceeds Morningstar's fair-value estimate of $10 per share.
The headquarters and management team will remain the same if the deal goes through, said Robert Ortenzio, president and chief executive officer of Select Medical. The company could take another purchase offer, but it would be subject to a $40 million breakup fee.
More information about the deal will be disclosed in a proxy statement that is expected to be filed with the Securities and Exchange Commission within the next couple of weeks, Ortenzio said.
The long-term acute-care, or LTAC, market was "turned upside down" with the admission rule changes the CMS completed in August, Ortenzio said. "That certainly was a factor" in the decision, he added.
The CMS rules were softened-they now call for a phase-in per-iod for existing LTACs-after much lobbying from the industry. Still, all LTACs that opened after Oct. 1 and are located within another hospital can only take 25% of their patients from the host hospital in order to receive full Medicare reimbursements.
Facilities operating before Oct. 1 aren't faced with any limitations through fiscal 2005, but starting in 2006, LTACs within other hospitals will be permitted to accept only 75% of patients from the host hospital. In 2007, they will be permitted to accept 50%; in 2008, they can accept only 25%. Free-standing LTACs do not face these changes.
Frank Morgan, a healthcare stock analyst for investment banking firm Jefferies & Co., said going private would allow Select Medical to handle the admissions transition away from the public spotlight.
Ortenzio said Welsh, Carson approached Select Medical with the offer and Terence Moore, senior analyst with Moody's Investors Service, said this deal is in line with Welsh, Carson's business model. Welsh, Carson didn't return calls for comment, but on its Web site it calls itself the largest equity investor in healthcare. One industry insider who asked not to be named suggested that Select Medical's depressed stock price might make it a good bargain for Welsh, Carson, which would expect to recoup its investment once the regulatory uncertainty surrounding LTACs has passed.
In March, Welsh, Carson was involved in a $1.7 billion deal that led to US Oncology going private. The company provides cancer care through its network of physicians. Similar to Select Medical, US Oncology was facing changes in Medicare reimbursements, said Scott Perricelli, vice president of LLR Partners, a private equity firm. US Oncology had warned that its 2005 earnings would suffer because of provisions in the Medicare Modernization Act that would reduce reimbursements for cancer care.
Perricelli added that it's easier for companies to work through these types of changes or growth periods without dealing with shareholders because revenue often takes a hit.
"Public companies worry about quarter to quarter," Perricelli said. "If you go private, you have a longer-term horizon, more like a five-year period, not quarter to quarter."
Select Medical had been experiencing financial growth recently. It reported 2003 net income of $74.5 million, a 68.4% increase from $44.2 million in 2002, on total revenue of $1.4 billion, up 24% from the previous year.
The majority of Select Medical's net operating revenue comes from its LTACs. They brought in $544.3 million, while its 761 outpatient rehabilitation facilities accounted for net operating revenue of $289.9 million through the first six months of 2004. Select Medical canceled its third-quarter earnings meeting, scheduled for Oct. 28, because of the deal with Welsh, Carson. In August, the company reduced the number of LTACs it planned to open in 2005 to four or five from its previous growth target of eight to 10.