7 Health Care Merger Plays

As health care costs have spiraled higher over the years, one side effect has
been to create a feverish pace of merger and acquisition activity in the health
care sector. In the second quarter of this year alone, the industry saw 243
acquisitions and mergers, according to Irving Levin Associates. M&A in the
hospital sector has been extremely busy, resulting in increasing concentration:
more hospitals owned by fewer companies in certain markets. A report by
America's Health Insurance plans noted that 80% of U.S. hospital markets in
2009 were highly concentrated. And other reports have put that figure as high as
90%. Mergers allow hospital groups to not only save money by sharing
administration costs but they also reduce expenses by virtue of the pricing
power inherent in a behemoth organization. Think of the pressure Wal-Mart (NYSE:
WMT ) has exerted in the retail sector by forcing its suppliers to lower prices,
and it's easy to imagine that a group of hospitals banded together could
certainly influence a range of costs to go down, including physician and nursing
salaries, prescription drugs and medical equipment, just to name a few. In
recent years, approximately 33 cents of every dollar spent on healthcare went
into the pockets of hospitals, so the more leverage a hospital has to negotiate
its prices, the more money it and its shareholders (if a publicly traded
entity) makes. Antitrust Could Become an Issue President Obama's signature
health care reform, the Affordable Care Act (ACA), which became law in March
2010, encourages the creation of more integrated delivery systems, called
accountable care organizations (ACOs). These, in turn, may further promote M&A
as a tool to increase physicians' and hospitals' leverage in certain
markets. The rise of mega-hospitals does raise some antitrust concerns (as well
as concerns that widespread closures of less-profitable or money-losing
facilities can leave many communities underserved), but until recently,
regulators have not seen fit to intercede to halt many mergers in the sector.
The Federal Trade Commission has stepped up its scrutiny, but the experts
don't predict any major impediments to what they see as an emerging trend.
Some analysts believe that ACA incentives now account for as many as 50% to 60%
of the deals that aim to join the forces of hospitals and physicians. And that
means opportunities for investors. The organizations that will benefit (profit)
the most will generally be those with the most leverage to negotiate their
payments and their costs in other words, the largest of the hospital chains.
Although I think investors will have an opportunity to see similar opportunities
in specialty clinics and physician groups, today I want to concentrate on the
major publicly traded hospital organizations. Short-Term Payoffs I do not, even
for one minute, believe that merging will solve all of their long-term problems.
In many cases the merger will likely make the whole worse than its parts. The
coupling of two or three independently managed businesses will bring
communication challenges as well as difficulty in combining all administrative
functions. If there is a financial efficiency payoff, it will likely not be
evident for the first few years after the merger. However, the stock market
generally rewards the shares of merging companies not on their long-term reality
pictures, but instead on the excitement that is stirred up by the mere
announcement of the merger and the potential benefits to the merging parties.
Consequently, I believe the payoff to investors will be mostly in the short term
and will be derived primarily from buying shares in the hospitals likely to come
out as winners in the M&A game before any actual deal occurs. Here are the
seven major publicly traded hospital stocks: Company Symbol Market Cap ($) P/E
Quarterly Earnings Growth (%-yoy) Community Health Systems Inc. NYSE: CYH 1.78B
7.59 5.5 Health Management Associates Inc. NYSE: HMA 2.24B 12.70 23.9 Kindred
Healthcare NYSE: KND 578.96M 12.61 -63.8 Lifepoint Hospitals NASDAQ: LPNT 1.87
12.13 n/a Skilled Healthcare NYSE: SKH 157.02M n/a n/a Tenet Healthcare NYSE:
THC 2.38B 12.10 -98.7 Universal Health Services NYSE: UHS 4.04B 12.04 52.9 The
group, as a whole, is quite leveraged and has been beset recently by some
insider selling, although nothing too significant. And that's not completely
surprising, given the general uncertainty in the sector. Fundamentally speaking,
CHA has one of the lowest valuations LPNT's debt/equity ratio, at 81.05, makes
it by far the least leveraged of the group, with SKH leading the pack in that
category at 712.27. That much leverage in a period when companies have been
drastically reducing debt is a bit worrisome to me. If I were looking to add
any of these companies to my portfolio for the long run, I would wait a bit to
see how the national health care discussions evolve. But on a technical basis
and thinking about a short-term opportunity to book some profits each of these
stocks look fairly compelling, with HMA's shares showing the strongest
potential, chart-wise. Caveat: If you decide to add any of these shares to your
portfolio, you will need to be very vigilant as to their trading activity. And
as I recommend to my subscribers, always set your sell target the day you
purchase the shares. Additionally, don't forget to protect yourself by setting
stop-losses for each stock. As of this writing, Nancy Zambell does not own a
position in any of the stocks named here.