Swirling Drama at Universal Health

Some investors want big changes at the hospital chain.
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Universal Health Services

(UHS) - Get Report

could be testing its investors' patience.

The urban hospital operator delivered another quarterly surprise on Thursday, with net income slipping but operating profits coming in far ahead of the anticipated range. The company's earnings per share beat the consensus estimate by 7 cents -- or 8.5% -- this time around.

But Universal investors, by now accustomed to huge upside and downside surprises alike, could be pining for some real drama these days. Notably, two big hospital chains have attracted leveraged buyout offers over the past year. Meanwhile,

Health Management Associates

(HMA)

has chosen to recapitalize itself. Thus, some feel that Universal should follow with a similar move of its own.

Earlier this month, Stanford analyst Gary Lieberman suggested that Universal borrow more than $1 billion to finance a huge stock buyback program. Lieberman estimates that the move could boost Universal's profits by 9 cents a share in 2007 and by three times as much the following year.

"If UHS does not significantly lever up its balance sheet, it risks seeing its EPS growth rate fall substantially behind its peers, which have increased their financial leverage," Lieberman stressed. "Therefore, the likelihood that UHS will significantly increase its leverage ratio is higher than most investors currently believe, in our view."

Right now, Lieberman portrays Universal as "somewhat of an enigma" in the publicly traded hospital sector. Notably, he says, Universal has less leverage than other players in the group. However, he says, the company has no intentions of going private even though its capital structure would easily allow it do so.

Because his family controls roughly 85% of the company's voting stock, Universal CEO Alan Miller can clearly call the shots. Still, regular shareholders could grow increasingly frustrated if the company chooses to do nothing different at all.

Thus, Lieberman feels that Universal should borrow the funds for a Dutch tender offer or a regular -- but significantly expanded -- stock buyback. He sees the latter, in particular, as a real possibility.

"UHS is unlikely to take the company private, unlikely to do an HMA-type of recap and has a history of repurchasing shares," Lieberman says. "Therefore, a gradual buyback would be consistent with UHS' previous actions and within the company's comfort zone, in our view."

Lieberman has a buy recommendation and a $62 price target on Universal's stock. His firm has no business ties to the company.

Meanwhile, HMA investors continue to wait for their own company's strategy to pay off.

Earlier this year, HMA borrowed heavily to fund a big one-time dividend that could buy the company some time. But HMA's operating results keep on deteriorating in the meantime.

Sheryl Skolnick, senior vice president of CRT Capital Group, believes that HMA cannot blame all of its problems on bad debts from the uninsured -- viewed as an "uncontrollable" expense -- either. Indeed, after closely analyzing the company's results for the past five years, Skolnick spotted another culprit entirely. For the most part, she said, controllable expenses -- for such items as labor, supplies and corporate overhead -- cut into the company's margins instead.

With HMA now employing more and more physicians, whose salaries can be high, Skolnick fears even more pain ahead.

"We're troubled because we remember the last time that hospitals got in to the physician practice management business," explains Skolnick, whose firm makes a market in HMA securities. "In the late 1990s, PPM companies ... were all the rage. But by the early 2000s, all but a couple were bankrupt -- including the ones owned by hospitals.

"We are reminded about what happens when one neglects to remember (and respect) the past."

Investors seem more understanding, however. They continue to cling to HMA's stock, remembering the company's glory days and keeping Skolnick on the sidelines with a fair value rating even though she clearly feels that the shares are overpriced.

Skolnick, for one, sees no reward ahead.

"There is no dividend, no share repurchase -- nor should there be, in our view --

and little to no cash flow this year," she says. So "it is our view that investors in HMA's common equity are not being paid to wait in any way, shape or form."