Cash is king, but at some point, shareholders are going to ask what a company is doing with that pile of greenbacks. With todays frozen credit markets, it may take a while, but those questions will come from those fortunate enough to have invested in companies that have squirreled away a lot of cash. Hospital companies, like those in other industries, have several ways to answer.
Take the money and ...
Experts: Four options, but most for-profits hold cash
Hospital chains, both analysts and academics agree, have four main options for their cash: acquisitions, capital projects in their existing facilities, and repurchasing either stock or debt. The latter two choices have looked especially enticing at times this year, as investors hammered both stock and debt prices so much that repurchasing either of them could lead to big returns.
Thats especially true with repurchasing debt in the secondary markets when it is trading at 60% to 70% of its par value, said Jon Santemma, managing director of global healthcare for UBS Securities. The stock market has rebounded somewhat in recent weeks and debt is trading a little closer to its par value, Santemma said, but there are still opportunities for companies that want to do buybacks (See chart).
For now, Santemma said, caution is ruling the day. The investor-owned chains, for the most part, have credit or cash available to them, they have the ability to spend money on any of these four options under their loan agreements, and they have modest maturities in the next few years (Nov. 3, 2008, p. 32). Understandably, Santemma said, companies are ensuring that no matter how long the recession and the credit crunch last, they are prepared. When the time for them to refinance does come, he added, their lenders will look much more kindly on healthy cash reserves than they will a stock or debt buyback that made great returns for shareholders.
Unless its a great, great deal, people are being risk averse and holding on to their cash, Santemma said.
While that may be a short-term negative for mergers and acquisitions, two professors said over the medium term of 12 to 18 months, its actually a positive sign that the companies believe that there will be great opportunities in buying and operating hospitals.
Michael Maher, a professor of management at the University of California at Davis Graduate School of Management, said healthcare is still a growth industry, despite the short-term situation, so it might make sense for the investor-owned companies to forgo the gains from financial management.
It could be a big advantage to have that cash when the market opportunities improve, and you can do some acquisitions or invest in your facilities, Maher said. That would be a reason that you would sit on the cash rather than buying back debt or stock. When you do those things, you sort of shrink the company. You reduce the capitalization of the company.
The downside, Maher said, is that the returns from holding on to cash are scant with interest rates so low. For a while, shareholders will understand managements forbearance, but if the cash persists for four or five years, they will demand some returns, he said.
Nikolay Halov, assistant professor of finance at the University of California at San Diego School of Management, said that all four of the investment choices for companies are judged against what is known as their hurdle rate, or the rate of return that an investment must exceed to be profitable to the company. This hurdle rate is generally the weighted average cost of capital, which accounts for both debt and equity capital, Halov said.
If the companies had rushed to repurchase their shares and debt earlier this year, when the returns were even greater than they are now, it would have been a sign that they do not have good investment opportunities in their core business, Halov said. If they expect that the future prospects may be even better than the returns from retiring debt, they may hold off spending their cash, Halov added.
Another reason that the companies may turn to acquisitions is for growth that volume is no longer fueling, said David Bachman, a senior research analyst covering healthcare facilities for Longbow Research. Theyre continuing to look at what deals are out there, Bachman said. A not-for-profit thats available at an attractive price and margin expansion possibilities, or a tuck-in acquisition to boost share in a market, theyre going to continue to look at those deals.
Bachman said that he expects the companies to continue to pile up cash in 2009, but they could be ready for acquisitions in 2010. I dont think theres a sense that they have to jump on any deals immediately or theyll miss it, he added.
For now, Bachman said, investors have low expectations for growth and simply want to see more cash and less debt. Add in the uncertainty of the economic climate and the prospects for healthcare reform, and there is plenty of reason to delay big strategic moves, he said.
I think the assumption is, at some point, we get through healthcare reform, volumes start improving, the bad debt issue gets resolved, and at that point, you want to be in the hospital business with a nice set of assets to take advantage of those improvements, but I think that is two or three years out, Bachman said. Thats not this year.
Send us a letter
Have an opinion about this story? Click here to submit a Letter to the Editor, and we may publish it in print.