Triad Triage Awaits Community

Some observers question the wisdom of the huge buyout.
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Some experts believe

Community Health Systems

(CYH) - Get Report

could soon regret becoming the nation's largest publicly traded hospital chain.

To achieve that lofty position, Community is buying

Triad Hospitals

(TRI) - Get Report

in a move that represents a departure from its proven operational strategy. The Franklin, Tenn., company surprised Wall Street in March by outbidding private equity buyers for Plano, Texas-based Triad.

Community, having made a name for itself by running efficient rural hospitals that monopolize their markets, is now paying $5.1 billion for a hospital chain that's known instead for making generous investments to lure patients in competitive markets.

Community CEO Wayne Smith cites "similar values" in saying the partners should fit together well. But critics see a looming clash of cultures that could play out in the executive suite as well as at the hospital level and even in the companies' information systems.

"I have the ... concern that the hospitals are completely different for the two companies," says Sheryl Skolnick, senior vice president of CRT Capital Group. She has no position in either stock and her firm has no banking ties to either company.

"What works in rural hospitals will not work in small-city hospitals like Triad's," says Skolnick, who recommends that investors sell shares of Community short and buy shares of Triad. "I think the Community-Triad deal is a disaster waiting to happen for Community shareholders."

Bidding War

Community won Triad by topping a leveraged buyout offer. The company promised Triad investors $54 a share -- a near-record price they haven't seen since mid-2005 -- in exchange for their company.

Community says the deal allows it to pick up a fleet of choice hospitals that, with some spending discipline, should deliver the strong returns that long-term investors crave. Otherwise, Community could have seen its stock languish with the rest of the group despite the company's consistent outperformance in a tough industry environment.

But with Community pursuing its biggest acquisition ever at a time when the entire industry has been hammered by bad debt from the uninsured, skeptics wonder if that price will prove too dear.

Some critics claim Community lacks the seasoned professionals necessary to run a second major fleet of large hospitals on its own. Community will operate 130 hospitals across 28 states, with its bed count more than doubling to 18,700, after the deal closes late this year.

Community hopes to retain some of Triad's key leaders, but has yet to announce who will be staying.

"I think we will get as many people as we would like" from Triad's executive ranks, Community chief Smith says. But "if I didn't think we had the management talent to do this

ourselves, we wouldn't have taken it on."

Further down in its organizational chart, Community employs four senior vice presidents who oversee hospital operations for the company. Smith portrays those executives as industry veterans who know how to run all kinds of hospitals. But one skeptic says only one of the four has deep experience managing bigger hospitals.

A related question stems from one industry insider's observation that Community -- often operating the only hospital in town -- has felt little need to court local managers and has, therefore, called the shots from the top.

"In Triad, the

local officers have been included in decisions, rewarded with stock, provided routine communication, etc.," says a hospital executive who is familiar with both companies. "For Community, all the wealth and respect is only at the corporate office. ... I just see a huge culture shock for Triad teams" in the days that lie ahead.

Payables, Receivables

Critics also worry about possible problems associated with the two chains' computer systems. Community sees more opportunities than challenges when it looks at those different technology platforms. But critics worry about setbacks nevertheless.

"One of the universal truths of system conversions is that you always have a delay in billing, and your receivables balloon at some point during the process," Skolnick says. "The only question is how deadly that loss of cash flow is to the business."

Community many not have much extra cash to spare. The company is borrowing billions of dollars to fund its acquisition and will sacrifice much of its future cash flow in order to pay down that heavy debt load. The company claims it can cut costs and raise Triad's margins, long pressured by its heavy investments, in a successful fashion that will make the deal pay off.

But that may not be so easy, according to some observers.

"Triad has always said that they will not have the best margins," stresses one hospital executive. "I think as soon as Community tries to push the margins, the medical staffs will push back and/or move their business to other areas."

Even fans of the takeover see risks.

"We should make one point very clear," says J.P. Morgan analyst Andreas Dirnagl, who has an overweight rating on Community's stock and whose firm owns at least 1% of Triad's shares. "This transaction will not make sense to those investors who believe that we will continue to see the negative trends that we have seen in the acute-care industry over the past few years."