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Glenview Capital Management's proxy fight for control of Health Management Associates

Introduction

Community Health agreed to buy HMA for $3.9 billion in cash and stock and the assumption of $3.7 billion in debt. On a per share basis, the $3.9 billion is comprised of $10.50 in cash and $3.15 in CYH shares (i.e., 0.0694 CYH-shares x $45.53 = $3.15 / HMA-share). The deal is expected to close in early 2014, that is, if 70% of HMA shareholders vote affirmatively.

However, Glenview Capital Management, a $6 billion hedge fund which owns 14.6% of HMA, doesn't like the deal.

The HMA deal is reportedly expected to be significantly accretive to CYH earnings in the second year following the close. CYH projected the "synergies of a deal at $150 to 180 million annually within 2 1/2 years" which apparently is partially-based on CYH's belief that HMA's average Medicare length-of-stay is about 50% longer than CYH's and can be reduced to a level more in line with CYH's experience.

Community Health CEO, Wayne Smith, says "Community [CYH] would be 'neutral' in a Health Management proxy fight and would work with "whomever is in charge of the company to try to consummate the deal." Asked if community would raise its bid, he said that "there's no reason for me to even comment because we have an agreed upon price" ... " (WSJ, 07-31-2013)

CYH presently has $4.4 in equity and $9.2 in debt.

HMA hired Morgan Stanley to consider strategic alternatives, following Glenview's initiating the proxy fight. From 2004 to 2007, HMA's stock traded between $20 and $25 but fell to lower valuations until Glenview started making waves. Recently, HMA's stock ranged between $14 and $17 ... so the $13.7 might well appear low to some eyes.

Discussion

Why does Glenview want to replace the HMA Board?

It's certainly plausible that Glenview simply thinks it would be a shame to sell HMA at a "low" price. According to Glenview, HMA has a fine collection of hospitals and the hospital industry has a bright future under Obamacare. And accordingly, 1/3 of Glenview's $6 billion fund is invested in 5 hospital companies. As a matter of fact, Glenview is the largest shareholder of both HMA and CYT, owning 14.6% and 9.6% of the common stock, respectively.

On the other hand, the hedge fund industry has not done well in the last year or two and Glenview might want to avoid being cashed-out right now, if possible. Glenview's real goal might simply be to accept the same price, but angle for more stock and less cash. (The WSJ has reported that HMA desired an all cash deal.) Or Glenview might plan to angle the deal so that Glenview gets some sort of under-the-table sweetener.

Is it plausible that HMA's operations could be improved?

Yes, it's plausible that HMA could be more profitable and command a higher price under better management. HMA's estimated 2nd quarter revenue, at $1.46 billion, is far below the average of analysts' expectations, at $1.73 billion. HMA's dismal revenue-estimate results in dismal earnings-per-share estimates of 5 or 6 cents, compared to the 10 or 11 cent average of the analysts' estimates. But does the problem really lie with HMA, or does the problem lie with the analysts and Glenview as they're too optimistic?

Sometimes it seems Glenview over-plays their hand. In a July 30, 2013 press release, Glenview cites that "HMA confirmed that for the 8th time in 11 years it now expects to miss its original earnings guidance ..." But Glenview doesn't allow that in those 11 years there were 44 opportunities to miss one's numbers. How did CYH fair in that period? Glenview does not say.

Nor does Glenview compare HMA to HCA or any other similarly situated companies that are more successful. Admittedly, Glenview does have many cringe-worthy examples to cite, but one can only wonder what successes, if any, might offset the cited failures.

According to Glenview, over the last 10 years HMA has failed to effectively run the company and cites the dismal 10-year average return of 0.5% per year. That is indeed dismal compared to the S&P500's 6.6% average annual return over the same period, with dividends reinvested in the S&P500. However, I calculated that HMA actually earned a 2.7% average annual return over the most recent 11 years, assuming HMA dividends were reinvested in the S&P500 and the selling price is $13.70, which is consistent with CYH's offer.

Glenview also took a dim view that HMA issued a special dividend a few years ago as a strategy to thwart a takeover. Well, that might well be damning evidence that HMA has poor management, but Glenview didn't prove its case. All they did was point a finger. A graph of HMA's stock price history shows a spectacularly steep $10 drop a few years ago, and the special dividend is why that steep drop of $10 per share occurred.

It may be foolhardy to blame HMA management for their current woes since others in the Hospital Management industry have similar woes. With Medicare's highest concentration being Florida, one might suspect that even a well run organization might run into a higher number of embarrassing incidents.

HMA is cooperating with ongoing investigations by the Department of Health and Human Services, the Justice Department and the Securities and Exchange Commission. CYH also has some of these same ongoing problems, and whether they are inherited or homegrown is unknown for both CYH and HMA.

The WSJ quotes Glenview describing the deal as "difficult to assess [whether or not CYH's offer] represents 'full and fair' value, or represents the price offered by an opportunistic acquirer to a distressed seller." Unfortunately, this makes Glenview sound unsure of their convictions and possibly raises questions about their motivations. Or, they might be just a little too honest in a candid admission that they might be all wrong. Glenview claims they have never been an "activist investor" (in an NBC interview), so this might simply be evidence of that.

Glenview probably has a lot more knowledge about this industry than most investors. Glenview probably has more to lose in reputation than anyone else, after all, if their proxy fight ends-up screwing HMA's shareholders, Glenview will have a much more difficult time winning the confidence of shareholders in Glenview's next proxy fight. So, my ignorance leaves me content to assume that Glenview is ethical and knows what they're doing, and failing that, then probably no worse than the incumbent Board.

Other Risks: Acceleration of Debt

It appears that HMA's Board will be replaced whether or not Glenview's proxy fight is successful. Unfortunately for Glenview, HMA has made the plausible claim that replacing the current Board (without the current Board's simple approval of their replacements) would constitute a change of control which, under the terms of various indentures, would constitute a default and accelerate the debt, requiring immediate payment in full. Approval (of the incoming Board) by the outgoing Board appears to be the sole requirement to avoid the change of control.

If a Board of Directors is supposed to act in the best interests of the patients and shareholders, then withholding the approval of a properly experienced and seasoned replacement Board, duly elected by the same shareholders that elected the outgoing Board just months earlier, would clearly be an act of malfeasance, infidelity, breach of trust or some-such-thing that any average lawyer could put his teeth into. However, not being a lawyer, mine is only a guess.

Other Risks: Failure to merge with the best partner

I don't know if CYH is the best merger partner, but they sure might be, given that both companies are comprised of rural hospitals and HMA's 71 hospitals are focused in the southeastern USA, with a strong presence in Florida, where CYH is weak. (Only 2 of CYH's 135 hospitals are in Florida.) If CYH is the "most logical" partner to merge with, then it seems probable that a new CYH-&-HMA deal could occur later, but there are no guarantees. CYH may not be capable of buying HMA later on, and a savvy competitor might wish to deny CYH a Florida franchise by buying HMA for a price higher than CYH is willing to pay, which might be lower than today's price.

The Healthcare Industry consolidation is being driven by efficiencies of size and purchasing clout, while healthcare reform and/or an ailing economy has slowed patient volume. The industry looks forward to reduced bad debt due to the individual mandate, but this is offset by a high-dependence on Medicare, Medicaid, HMO's and Obamacare, all of whom will continue to rein-in expenses. Glenview must have concluded that the industry is poised for growth in spite of all this, perhaps because of our aging population and poor health habits guarantee higher and higher demand.

The turmoil involved with a proxy fight might result in HMA being among the last firms to merge, and last to enjoy the benefits of sheer size. However, if one successfully improves operations, being last might make HMA more valuable. That might make the risk worth it ... or so Glenview must believe.

Other Risks: Missing today's high-flying stock market

If and when the Federal Reserve ("the Fed") reduces QE3, the stock market is bound to lose 10% to 15% as it did when Chairman Bernanke mentioned in May 2013 that a reduction in QE3 would occur later this year (and then of course, he back-pedaled to re-assure markets that QE would be available as needed).

Monetary policy seems to have created a quagmire, from which the economy will have difficulty emerging. The stock market could stagnate for years, especially if the Congressional Budget Office has correctly predicted the Federal budget-deficit will fall until 2015, and increase thereafter. This prediction is based on a lot of moving parts:

A struggling economy can adversely affect the predictability of federal income tax proceeds, and federal income taxes can affect the performance of the economy. Each affects the other.

The bond market has a direct effect on the stock market; the stock market has an indirect effect on the economy (via the "wealth effect"); the economy affects the bond market's ability to fund the bonds required to fund the budget-deficit. Each affects the others.

Rising interest rates have an effect on the National Debt interest payments, government spending, the budget deficit and the economy. Each affects the others.

Record-high government spending has an effect on the 'invisible hand' of the markets, in large part replacing it with the blundering hand of government. The blundering hand of government is insensitive to wasteful spending, as private enterprise or individuals would have incentive to constantly find the best price, product or service.

Assessing the health of the economy is more prone to error. A teetering economy, even if improving, can turn on a dime and head south. This is not conducive to normal business investment.

Record-high budget deficits have an adverse effect on the bond market which is presently ameliorated by QE3, until QE3 comes to an end.

Etc, etc, etc.

Surely, the Fed cannot continue QE forever. But how far they can push it is unknown. Bernanke's back-pedaling seems to belie his belief that the economy needs just a little more time to heal, and once healed, hopefully the economic engine will be able to shoulder the federal budget deficits as in a normal economy. And this is the hope of all U.S. taxpayers.

Summary - When QE3 is reduced, there will be less demand for bonds, resulting in lower bond prices, resulting in lower stock prices. Lower stock prices wouldn't hurt in an all-stock deal, and an all-stock deal seems likely since there's ample evidence that Glenview is a long term investor.

Action:

I recommend siding with Glenview, but not because they've proven anything. They've raised suspicion about the acquisition price and HMA's current management; they've raised the stock price; they've been successful, averaging a 15% annual return over the last 10 years; and they've got 33% of their $6 billion fund riding on this industry.

If you're a shareholder of Health Management Associates (NYSE:HMA), you may have already received two proxy solicitations on the Glenview vs. HMA proxy fight:

1.) A "yellow" proxy from Glenview (also referred to as the "gold" proxy)

2.) A "white" proxy from HMA

I recommend voting with Glenview (the yellow proxy) which is voting against the Board of HMA. I'm guessing that allowing Glenview to replace the entire 10-man board with their own 8-man board will turn-out better than selling to Community Health (NYSE:CYH) for $10.50 cash plus .0694 shares of Community Health. Admittedly, I don't have overwhelming confidence that this decision is the best choice, as it merely edges-out the option of selling HMA for what seems like a distressed price.

The "yellow consent" proxy solicited by Glenview is intended to enable Glenview to replace the board. Vote in each of 22 boxes in the "Consent" column.

The "white consent revocation" proxy is solicited by HMA to fend-off the takeover by Glenview. To vote for Glenview's replacement of the entire Board, vote each of 22 boxes in the "No, Do Not Remove My Consent" column. Unfortunately, I believe that if you do not mail-in your white proxy, your white proxy is automatically counted against Glenview's take-over. In other words, I believe that if you want to let Glenview take over the Board, you will need to send in both the yellow proxy and the white proxy ... and both must be properly voted.

The deadline to submit the yellow proxy from Glenview is August 19, 2013. For more information, contact Okapi Partners LLC toll-free at (877) 869 - 0171.

Another proxy from HMA is expected soon to approve the sale of HMA to Community Health, at what seems to be a distressed price. I suggest that shareholders should not approve it. HMA needs approval of 70% of the shares to be acquired. Glenview already owns 14.6%, so Glenview needs only 15.4% to stop the sale to Community Health.

According to Okapi Partners, Glenview needs a simple majority of shareholders ( "50% + 1" ) to elect Glenview's replacement Board.

Disclosure: I am long HMA, CYH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Glenview Capital Management Vs. Health Management Associates