Community Draws Questions

Some wonder if an even bigger LBO isn't in the works.
Publish date:

With plans to buy


(TRI) - Get Report

and become the new industry heavyweight,

Community Health Systems

(CYH) - Get Report

is being compared to two very different hospital chains.

Some see another HCA, suddenly big enough to attract a leveraged buyout offer. On the other hand, some see a new


(THC) - Get Report

-- burdened by a huge debt load in a brutal industry environment.

"As an end-game 'transformational' transaction, this deal only makes sense if the fundamentals of the industry are markedly improving," writes Morgan Stanley analyst Christine Arnold, whose firm seeks to do business with the companies it covers. "Alternatively, combining TRI with CYH's strong cash flow could create a more compelling LBO candidate than either company alone."

Arnold continues to express strong faith in Community regardless. She has an overweight recommendation and a $39 price target on the company's stock, which has long outperformed others in the tough hospital group. The shares, hurt recently by worries about the Triad deal, inched up 14 cents to $34.01 on Wednesday.

But Sheryl Skolnick, senior vice president of CRT Capital Group, fears that Community could be making an expensive mistake. She recommends shorting Community and buying its target as a result.

Meanwhile, Skolnick questions why Community ever pursued the deal at all. She points out that Community has suspended its guidance for the first quarter even though the company expects the deal to close well after that. Thus, she wonders, did Community chase after Triad because it felt unable to hit its targets on its own?

"The company said that it suspended guidance due to its desire to close the TRI transaction quickly," Skolnick concedes. "But when we asked whether that meant that CYH didn't have the bandwidth to both operate the company well


close a transaction, management was quick to understand the implications of its statement and to back away from that argument."

Whatever its reasons, Community is moving forward with its plans. Skolnick sees no competing bidders stepping in, because Community has already offered "a significant premium to any conceivable or rational multiple based on Triad's recent and likely future performance." Looking ahead, Skolnick fears that Community's own performance could suffer for years.

Specifically, Skolnick expects the buyout to hurt Community's earnings and free cash flow through at least 2008. She, therefore, sees shareholders waiting some 21 months -- and possibly longer -- for any payoffs to materialize.

Skolnick, for one, questions why Community is testing the patience of shareholders who seemed satisfied already.

"CYH is turning itself into as highly leveraged a turnaround play as Tenet Healthcare," Skolnick writes. But "CYH is, in our view, making itself into a turnaround play when it didn't need to be."