Community Holders Cash-Cowed

Delaware law says holders can't vote on the all-cash Triad deal.
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Community Health Systems'

(CYH) - Get Report

rich buyout of

Triad Hospitals

(TRI) - Get Report

is leaving some investors feeling disenfranchised.

Community

turned heads on Wall Street last month by topping a $4.6 billion leveraged buyout offer for Triad. Community won the day by promising a near-record price of $54 a share, or $5.1 billion, for its Plano, Texas-based peer.

Both companies' boards unanimously approved the huge takeover, which will double Community's size and stretch its operational strategy. Now Community needs the blessing of Triad shareholders to seal the deal.

But shareholders of Franklin, Tenn.-based Community won't be voting. The deal doesn't require their approval, observers say, because of a little-appreciated legal distinction involving the currency used in an acquisition.

Because of the vagaries of Delaware law, shareholders of the acquiring company must vote on a deal in which their company issues stock. But Community has indicated that that wasn't an option with Triad.

"We are willing to be the successful bidder," Community CEO Wayne Smith explained in a conference call focused on the buyout. "I think it was a cash deal, and I think that was what was required to get it done. ... I just don't think we would have been successful with stock."

Smith could be exactly right. After all, Community was competing with an all-cash offer that was already on the table. Moreover, hospital stocks -- including Community's own -- have been languishing in a tough industry environment.

Of course, even without a vote, shareholders always have the option of selling their shares. Community Health investors haven't been doing that, despite worries in some quarters about the deal's price and difficult operating conditions. Shares of the company have doubled since 2003 and are just a dollar below their level ahead of last month's buyout announcement.

And from the standpoint of Triad investors, the sale to Community has been a dream. Shares are trading at their 52-week high, and Triad's handling of its auction struck some observers as a

model of enlightened corporate governance.

Even so, some observers contend that Community shareholders should have some input. They blame a loophole in Delaware corporate law for the problem.

Back when that law was passed in the 1960s, they say, Delaware-incorporated companies such as Community would have found it harder to borrow enough money to pay cash in huge transactions. Thus, they say, the companies would have relied on stock -- and shareholder approval -- for big deals. But in today's environment of easy credit, they add, those companies have no problem borrowing billions.

"Community shareholders have been locked out, and that's a real problem," says Richard Clayton, research director at CtW Investment Group. "This is certainly a circumstance in which a company ought to make a case to its shareholder -- and ought to have to make it."

CtW works with union-sponsored pension funds that own sizable chunks of Community's stock. Already, Clayton says, some of those funds have expressed concern -- and even frustration -- about the company's current plans. Specifically, he adds, they worry about both the price and the rationale for the pending deal.

For its part, Community has portrayed the price tag on Triad as fair. The company says that it has paid a similar amount -- based on a revenue multiple -- for other hospitals in deals that have worked out well.

But others question the deal.

Sheryl Skolnick, senior vice president of CRT Capital Group, says Community is paying "a significant premium to any conceivable or rational multiple based on Triad's recent and likely future performance."

As a result, Skolnick recommends that investors buy Triad and sell Community short. She has no position in either stock, and her firm has no ties to either company.

Down the road, critics fear, Community could wind up with a huge case of buyer's remorse. Not only is Community overpaying for Triad, they believe, but it is also buying much larger hospitals than it is used to running -- and a lot of them at one time.

Notably, Community has enjoyed great success by focusing on rural hospitals that monopolize their markets. Now, however, the company is adding a slew of larger hospitals that operate in competitive markets instead.

Some people worry as a result.

"Company leadership hasn't offered a good argument about why this makes sense," Clayton says. "They haven't convinced the skeptics yet. They might be able to get there -- but they're going to have to do more."