|Merger Analysis Case Study|
|Question Detail: |
Merger Analysis Case StudyFranklin Teaching HospitalCurrently, three hospitals serve the patient base of Palmetto County, Florida, which has a population of about 220,000. The hospitals include the following:Franklin Teaching Hospital, a 525-bed, not-for-profit university-related teaching hospitalSuncoast Regional Medical Center, a 200-bed, for-profit hospital owned by Senate Healthcare, a national chainPalmetto General, a 400-bed, not-for-profit, acute care hospital owned by Citrus HealthcareThe service area has a total of 1,125 licensed beds for 200,000 people, or 5.1 beds per 1,000 people, which is higher than the national average of about 3.1 beds per 1,000 people, and much greater than 2 beds per 1,000 people needed under moderately aggressive utilization management. Of course, as a tertiary care facility, Franklin Teaching Hospital receives patients from throughout the state, but the bulk of its patients still come from the local five-county area.With an excess capacity of hospital beds, the status quo may not survive the changing healthcare environment. Indeed, Palmetto General has had some tough years recently, as evidenced by its number of discharges, which have fallen to 11,412 in 2006 from 12,055 in 2005 and 12,824 in 2004. Additionally, Senate Healthcare has been aggressive in building market share in other areas of Florida through acquisitions. As a result of these factors the local hospital market is likely to witness some consolidation, and the most likely result is the acquisition of Palmetto General by either Franklin Teaching Hospital or Senate Healthcare.Palmetto General operated as a county hospital for over 50 years and consequently developed a reputation for providing healthcare services to the poor. After many years of operating losses, the county concluded that it could no longer afford to operate the hospital. So, in 1983, the county sold the hospital to Citrus Healthcare, a not-for-profit managed care organization and provider, which by 2006 had become the state’s largest integrated healthcare company.Citrus Healthcare’s major business line is managed care. Its numerous plans, including HMO (Health Maintenance Organization), PPO (Preferred Provider Organization), POS (Point of Service plans), Medicare, and Medicaid, serve over 400,000 members in 31 Florida counties, encompassing all of the major metropolitan areas. In addition to managed care plans, Citrus Healthcare owns nine different providers: two acute care hospitals including Palmetto General, two primary care hospitals, one rehabilitation hospital, one mental health facility, one hospice, one home healthcare provider, and one retirement facility.Palmetto General is the flagship of Citrus Healthcare’s provider network and as such the company hlas maintained the hospital well in spite of falling inpatient utilization. In fact, in recent years, Palmetto General has built a new, state-of-the-art Heart Care Center and a modern Maternity Care Center. Furthermore, Palmetto General operates a full-service emergency department and a medical emergency helicopter service.In response to the current situation, Franklin Teaching Hospital has formed a special committee to consider the feasibility of making an offer to Citrus Healthcare to acquire Palmetto General. The committee’s primary goals are as follows:To place a dollar value on Palmetto General’s equity (fund) capital, assuming that the hospital will be acquired and operated by Franklin Teaching HospitalTo develop a financing plan for the acquisitionIn addition, the committee has been asked to consider two other issues related to the potential acquisition.What is the best organizational structure for a combined enterprise? Currently, both Palmetto General and Franklin Teaching Hospital have separate boards of directors and management staffs. Of course, the senior members of the board of Palmetto General currently are Citrus Healthcare officers.Should the medical staffs of the two hospitals be integrated, and, if so, in what way? The medical staff of Palmetto General consists of local physicians, including many family practice physicians, while the medical staff at Franklin Teaching Hospital is almost entirely made up of specialists, and all are members of Franklin University’s College of Medicine with responsibilities that go well beyond clinical practice. A new committee will be formed to address the above issues should Franklin Teaching Hospital’s management agree to move forward with the acquisition offer, but some preliminary judgments are sought at this time.As a starting point in the valuation analysis, the committee has obtained historical income statement and balance sheet data on both hospitals. Table 1 contains the data for Palmetto General, while Table 2 provides the data for Franklin Teaching Hospital. Note that both sets of statements focus on operating data, which are considered to be most relevant to the analysis. In addition, some relevant comparative data are presented in Table 3. Finally, relevant market data are contained in Table 4. (Note that the data in Tables 3 and 4 reflect late 2006 conditions.)One of the toughest tasks that the committee faces is the development of Palmetto General’s pro forma cash flow statements, which form the basis of a discounted cash flow valuation. Two basic questions must be answered before any numbers can be generated. First, what synergies, if any, can be realized from the merger and how long will it take for any synergies to be realized? For example, can duplications be eliminated? Both hospitals have mercy flight helicopters and both offer full emergency department services, even though the two hospitals are less than two miles apart. And, what is the impact of such operational changes on revenues and costs and hence on the net cash flows that Palmetto General’s assets can produce? Second, once the consolidation takes place and all synergies have been realized, what is the long-term growth prospect for Palmetto General’s cash flows? The answers to these questions, and others, form the basis for the pro forma cash flow estimates.Assume that you are the chair of the special committee formed at Franklin Teaching Hospital to evaluate the potential acquisition. You must present your findings and recommendations to the hospital’s board of directors. Note that Tables 1 through 4 contain far less data than normally available to parties involved in merger analyses, especially when the potential merger is friendly. In effect, the case discussion and accompanying data raise many more questions than they answer. You will be required to make a myriad of difficult assumptions to complete the analysis. Although you do not know much about Palmetto General’s local market, you do know the current trends in the health services industry. Use this knowledge to help make judgments about the case. The quality of many, if not most, real-world financial analyses depend more on the validity of the underlying assumptions than on the theoretical correctness of the analytical techniques.Note: There is no preferred solution to this case, so your case analysis will be judged as much on the assumptions used in the analysis as on the analysis itself. Finally, remember that numerous risk analysis techniques are available that can be used to give decision makers some feel for the risks involved.Table 1: Palmetto General Hospital: Historical Financial Statements (in millions of dollars)20022003200420052006Income StatementsInpatient revenue81.62488.24999.010105.332110.384Outpatient revenue22.86127.06734.62843.61650.810Gross patient revenue104.485115.316133.638148.948161.194Allowances and discounts33.69938.62644.62251.19862.006Net patient revenue70.78676.69089.01697.75099.188Other operating revenue1.9221.5151.3671.7251.048Total operating revenue72.70878.20590.38399.475100.236Patients services expenses60.24573.85881.52590.64589.505Interest expense3.0453.1473.0933.0022.980Depreciation3.4663.6894.3954.2586.031Total operating expense66.75680.69489.01397.90598.516Net income5.9522.4891.3701.5701.720Balance sheetsCash and investments2.3881.5380.1620.1850.198Accounts receivable18.86020.58120.82121.57016.732Other current assets4.5398.4754.6692.5852.898Total current assets25.78730.59425.65224.34019.828Gross plant and equipment102.596116.694122.611133.499146.130Accumulated depreciation27.24330.50534.90039.15845.189Net plant and equipment75.35386.18987.71194.341100.941Total assets101.140116.783113.363118.681120.769Current liabilities9.18213.5845.77110.68911.431Long-term debt33.57247.30250.32549.15548.781Total liabilities42.75460.88656.09659.84460.212Fund balance58.38655.89757.26758.83760.557Total claims101.140116.783113.363118.681120.769Table 2: Franklin Teaching Hospital: Historical Financial Statements (in millions of dollars)20022003200420052006Income StatementsInpatient revenue238.510287.559328.047363.236398.997Outpatient revenue47.96357.35169.25289.992103.746Gross patient revenue286.473344.910397.299453.228502.743Allowances and discounts82.053107.256128.645170.058185.301Net patient revenue204.420237.654268.654283.170317.442Other operating revenue5.5878.89912.19322.6729.979Total operating revenue210.007246.553280.847305.842327.421Patients services expenses178.788207.596231.673254.704277.938Interest expense9.23210.46811.98310.6919.997Depreciation13.28916.63719.62123.28626.489Total operating expense201.309234.701263.277288.681314.424Net income8.69811.85217.57017.16112.997Balance sheetsCash and investments17.91819.86224.66027.72625.220Accounts receivable66.21272.98999.867100.29797.494Other current assets12.31516.77120.74120.54222.757Total current assets96.445109.622145.268148.565145.471Gross plant and equipment348.288341.064335.313362.152400.546Accumulated depreciation75.13976.57590.056109.468123.567Net plant and equipment273.149264.489245.257252.684276.979Total assets369.594374.111390.525401.249422.450Current liabilities42.43735.06139.51137.73339.817Long-term debt146.997147.038141.432136.773142.893Total liabilities189.434182.099180.943174.506182.710Fund balance180.160192.012209.582226.743239.740Total claims369.594374.111390.525401.249422.450Table 3: Selected Comparative DataPalmettoFranklin TeachingAverage age of plant6.8 years8.5 yearsLicensed beds400525Occupancy rate52.7%64.2%Average length of stay5.5 days6.6 daysNumber of discharges11,41219,748Medicare percent57.2%29.7%Medicaid percent10.3%13.0%Medicare case mix index1.512.13Gross price per discharge$11,688$20,204Net price per discharge$5,850$12,757Cost per discharge$5,703$12,144Table 4: U.S. Treasury Yield CurveMaturityInterest Rate6 months3.01 year3.55 years3.910 years4.520 years5.030 years5.1Market Risk PremiumHistorical risk premium7.0%Average current risk premium as forecasted by three investment banking firms6.0%Market Betas, Capitalization, and Tax Rates of Two Publicly Traded Hospital CompaniesCompanyBetaDebt/Asset RatioTax RateProvident Healthcare1.150%40%National Health Company1.265%43%Ratio of Stock Price to EB1TDA per shareProvident Healthcare6.1National Health Company7.9Ratio of Total Equity Market Value to Number of DischargesProvident Healthcare$7000National Health Company$6000Ratio of Total Equity Market Value to Number of DischargesLarge hospital average5.0%Note: The data in this table reflect assumptions to ease the case analysis, as opposed to actual data.
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