HCA Musings

“Biggest deal ever and you punt? You’re a punk.”

That was one of the more printable responses I received yesterday, after failing to analyze the proposed $33 billion buyout of urban hospital chain HCA Inc. And it was deserved. So what follows is a humble attempt to regain your good graces, with some assorted notes on (what might become) the largest LBO since KKR was just a gleam in Jerome Kohlberg’s eye:

*** The cash equity tranche is expected to be around $5.4 billion, not including the rollover of company founders and management. Because each of the firms signed on to the deal as equal partners, this works out to $1.8 billion per firm. Those checks will not be written.

Instead, expect further equity syndication. KKR is certainly in a stronger financial position than either Bain Capital or (presumably) Merrill Lynch Global Private Equity, but $1.8 billion would still be around 10% of the fund it’s currently raising. That’s pushing the upper limits of portfolio diversification. Bain’s current fund is “just” $10 billion, meaning that HCA would account for 18% of its portfolio capital. The Boston-based firm apparently doesn’t need limited partner approval to make such a move – regular readers know that Bain gets the biz’s best terms – but it nonetheless would violate some traditional private equity protocol. Merrill told the WSJ this morning that it will likely spend a bit more than $1 billion, which I’m reading as not “almost $2 billion.”

In addition to portfolio diversification concerns, all three firms certainly understand that this deal comes with more than its fair share of event risk. For example, there could conceivably be severe Medicare cuts before this deal is exited in 2010-2012.

So who else gets to play? First up will be limited partners of both KKR and Bain, per co-investment arrangements. Next will be the myriad of other private equity firms that are tepidly considering a rival bid for HCA. Apollo, TPG, Warburg Pincus and Blackstone are the most common mentions here due to capital capacities, although Blackstone already has high hospital exposure – albeit more rural -- with $500 million invested in Vanguard Health Systems. Another possible player could be Welsh Carson Anderson & Stowe, whose team includes former Medicare/Medicaid chief administrator Thomas Scully.

*** There are currently three major events that could scuttle this deal. First up would be a superior bid, but no one seems to be expecting one. HCA’s rivals can’t afford it, and interested private equity firms could just tag along with the existing consortium (at a lower price). Next would be debt market rejection, although this too is unlikely, since hospitals are the type of cash cows that help bankers obtain such good medical care when they themselves get sick.

The final stumbling block is also the most intriguing: Political and/or regulatory interference. This deal is rightfully being compared to SunGard – similar structure with many of the same transactional attorneys – but SunGard isn’t involved in saving people’s lives. This is an election year, so expect some Congressional candidate to make hay of greedy barbarians coming to invade their district’s local hospital. This is unlikely to have much punch given that HCA is already an investor-owned for-profit hospital, but it would still make for a good sound-bite in late August.

*** One reason I so dislike the SunGard deal is that the company was traded up so highly in the months preceding the final deal. The impetus then was a leak to the NY Post. In this case, the only press leak came via a WSJ story last week that claimed the deal was dead. Obviously not so, and I’m told that the article had a negligible impact on negotiations. “The story appeared during the usual process of going to special committee, and the special committee almost never says yes to the first thing you say,” says a source involved in the deal. “I assume that the source came from that.”

*** Finally, what does the HCA buyout mean for overall LBO firm interest in the hospital sector? Probably a small spike in activity followed by a return to normalcy (i.e. low activity).

There simply aren’t that many attractive hospital chains available in the long-term. Tenet would perhaps be targeted if/when it straightens out its many troubles, while a Lehman Brothers note offers up both Health Management Associates and Triad Hospitals (HMA is more likely, given its rural focus). These are all the LBO dream of high cash-flow businesses trading at cyclically-low valuations, but there still simply are not enough of them – or enough health services competency at private equity firms – to presage a major run on the sector.

*** Unrelated: Q2 venture capital disbursement data was released today by the MoneyTree Three of PricewaterhouseCoopers, the National Venture Capital Association and Thomson Financial. The totals are $6.3 billion for 856 deals, or the highest tally since Q1 2002. More on this tomorrow, but you can get all the particulars at www.nvca.org.