Health Management Associates (NYSE:HMA) has agreed to be acquired by Community Health Systems (NYSE:CYH), which will pay around $4 billion and take on the equal amount of debt as the consideration for the transaction. The combination is expected to be a system for healthcare, which is better positioned to compete in the rapidly changing scenario in the United States. The deal is subject to the normal conditions, but it is widely expected that there will be no trouble in getting the necessary regulatory and shareholder approvals. This is a pretty good deal for HMA shareholders who will receive cash payments of $13.78 a share as well as contingent value rights depending on the outcome of ongoing investigations that could provide an extra $1 per share to the effective price. Without the contingent value rights, Community's offer currently makes available a premium of around 3%, and the addition of the CVR enhances this premium to around 10%.
Community Health Systems has a bigger headcount and bed count than HMA, but both companies are well known in the American healthcare industry. Community Health Systems operates hospitals and clinics in 29 states within a fairly tight area surrounding its Tennessee headquarters. Health Management Associates, with clinics and hospitals in around 20 states, is also focused on operating in the Southeastern and Mid-Atlantic regions of the United States. In fact, Health Management is already present in all the states in which Community operates and both companies provide similar services, including full-service hospitals, walk-in clinics, outpatient specialists, facilities for surgery, cancer treatment, and so on.
In response to the implementation of the Affordable Care Act, hospital companies are still working out how to respond. It is generally accepted that hospital systems will need to live with lower profits and margins; many small and medium-sized companies are entering into alliances that enable them to exploit the economies of scale. This deal will certainly create synergies for the combined company, and, once it has digested Health Management, Community may be able to centralize some of its activities and close some of its smaller, less profitable facilities without affecting service and coverage. Additionally, it may choose to experiment with data-gathering systems and outsource menial medical tasks to low-cost overseas facilities.
Health Management Associates' second quarter finances
Health Management Associates reported EPS from continuing operations of $0.03 per diluted share. Adjusting for approximately $19.3 million (or $0.04 per diluted share) relating to interest rate swap accounting and mark-to-market valuations on the swap, diluted EPS from continuing operations was $0.07 per diluted share in comparison to $0.21 per diluted share in the previous year on net revenues of $1.464 billion. The results fell short of Wall Street expectations. Cash flow generated by continuing operating activities for the quarter was $108.3 million, after making cash interest and cash tax payments totaling $61.7 million. At June 30, 2013, total leverage ratio and interest coverage ratio were at 4.1%, which was well within the requirements of its debt covenants.
For the six months ended June 30, 2013, Health Management had net revenue of $2.947 billion and adjusted EBITDA of $380.1 million. Excluding the impact of approximately $37.0 million ($0.09 per diluted share) for interest rate swap accounting, as well as mark-to-market adjustments EPS from continuing operations, were $0.21 per diluted share. Consolidated EPS per diluted share from continuing operations were $0.12 for the period.
The role of Glenview Capital Management
Glenview Capital Management, which owns 14.6 percent of HMA stock, has decided to play the activist shareholder and decided to get rid of the entire board of directors of HMA after a fight that has lasted some months. Even the proposed sale to Community Health Systems has not been sufficient to ward off Glenview. Glenview says that it does not like to act in an activist fashion, and this is the first time it has openly taken on a company's board of directors. It is seeking to establish that company boards must work constructively to improve shareholder value and ensure that shareholders are treated as partners of the management. It further says that if these two objectives are not met, shareholders should actively seek change. Glenview says it expects to "ensure a smooth transition to be affected this week." After Glenview's nominees take over the board, the next step will be to review the $3.9 billion deal. The fund said that would happen in several months, in line with the timetable the companies had proposed and would not cause further delays. On August 12, Glenview Capital Management LLC announced that it has won shareholder approval for its plan to replace the entire board of directors at Health Management Associates Inc.
HMA is currently trading at $12.93, which means that there is an arbitrage premium provided the Community Health Systems goes through at the announced offer price of $13.98, and that the CVR premium of $1.00 is realized, making a total of $14.98 per share. If you are convinced that this is going to happen, you could buy and cash in on the arbitrage premium. However, I would recommend that, as a matter of prudence, you should watch future developments before taking action of any kind.