Tickers in this Article: CYH, THC, HMA, LPNT, UHS, MDTH, AMSG
Community Health (NYSE:CYH) is taking a time-tested route in its efforts to seal a deal to acquire fellow hospital operator Tenet Healthcare (NYSE:THC) - if you cannot get the other company's board of directors to say "yes," take the negotiations public and hope that your target's shareholders force the matter. While Tenet's arguments for rejecting the deal are not without merit, the 50% jump in Tenet's stock price suggest that shareholders would like a deal and expect an improved offer to come.

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The Deal That Community Health Wants
Community Health, an operator of 126 hospitals in largely suburban areas or small communities, is offering a $7.3 billion deal to Tenet shareholders, including an equity offer of $3.3 billion. In addition to taking on Tenet's substantial debt, CYH would give Tenet shareholders $6 per share in consideration for their shares - $5 in cash and $1 in CYH stock. That deal would have represented a 40% premium for THC shares. (For more, see Mergers And Acquisitions: Understanding Takeovers.)

All in, this would create a hospital operator with 176 locations in 30 states. In contrast to CYH, Tenet operates mostly in urban areas, so there would not be all that much overlap between the two companies. Moreover, this would create the largest hospital operator in the country, surpassing once-public HCA and its 163 hospitals across 20 states. It would also create a highly-leveraged company, with upwards of $15 billion in debt being serviced by less than $3 billion in EBITDA.

Does THC Protest Too Much
In rejecting CYH, Tenet's board pulled out some of the tried and true tricks we have all heard before [and most recently with Genzyme (Nasdaq:GENZ) and Sanofi-Aventis (NYSE: SNY)]. According to Tenet, CYH's bid is opportunistic, comes at a period of cyclically low valuations in the sector and short-changes THC shareholders vis-a-vis management's plans for a glorious future. On top of that, Tenet points out that the combined company would be highly leveraged (which is true), that CYH has minimal experience integrating hospitals in Tenet's market (also arguably true), and that CYH may have problems adopting Tenet's corporate integrity agreement (an interesting point). (For more, see Investing In The Healthcare Sector.)

Still, a few points must be raised in rebuttal. CYH acquired Triad years ago (in 2007) and did an exemplary job of integrating that company and it is not as though urban hospitals are so drastically different in operations as to be incomparable. Moreover, Tenet has been struggling from an operating perspective and offers below-average margins and looming debt maturities.

So while it may be true that Tenet can do much better (that is an inherent advantage to being below-average), its disingenuous for Tenet's board to fail to recognize that a 40% (or better) premium is a risk-free benefit to Tenet shareholders. Moreover, they must justify exposing their shareholders to the risk that the company's own plans will not deliver a better risk-adjusted performance.

Where To From Here?
With Tenet now "in play", it is worth wondering whether another bidder will step up. HMA (NYSE:HMA) and Lifepoint (Nasdaq:LPNT) are both smaller than Tenet in terms of revenue and EBITDA (as well as market cap now), so they are not probable candidates. Private equity, then, would be the better bet, though shareholders should not rule out a higher bid from CYH - Community Health can probably go up to $7 or $7.50 a share for Tenet without totally destroying synergy benefits. By the same token, if Tenet remains intransigent, CYH could look at those other players, as well as United Health Services (NYSE:UHS) or even smaller hospital companies like MedCath (Nasdaq:MDTH). (For more, see Sector: Play Or Stay Away?)

The Bottom Line
On the whole, another round of mergers in hospitals makes some sense. Companies like AmSurg (Nasdaq:AMSG) have done some lasting damage to the business model, and it is a far from proven fact that U.S. health care reform will mitigate the financial damage inflicted by uninsured patients who cannot pay for services rendered. Moreover, companies like Intuitive Surgical (Nasdaq:ISRG) and Varian (NYSE:VAR) offer great state-of-the-art capital equipment that can improve medical outcomes, but at the cost of high cap-ex budgets. All in all, it is hard to see how Tenet is better served by staying independent, but there is no reason for the board not to try to extract a better price before bowing out.

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