Community Health Stands Tall

As hospital investors ache for a suitor like the one HCA ( HCA) got, Community Health Systems ( CYH) is standing on its own two feet.

Over time, Community has built itself into the largest and most successful for-profit rural hospital chain in the country. After HCA goes private, in fact, Community will operate more acute-care hospitals than any other publicly traded company.

Unlike so many of its peers, Community has managed to meet Wall Street targets through even the roughest of times. The company is expected to continue that streak when it reports second-quarter results after the market closes on Wednesday.

Community is expected to post an 8.2% profit rise on a 13% jump in revenue, despite the bad debt and reimbursement woes holding down numbers across the industry. On average, analysts are looking for the company to make 53 cents a share on sales of $1.04 billion.

Community has long relied on a proven formula for success. The company likes to acquire struggling rural hospitals -- which often monopolize their markets -- and then turn those facilities around.

In contrast, HCA, for one, has focused on urban markets that can be especially susceptible to negative industry trends like weak patient admissions and bad debt from the uninsured. Meanwhile, competing rural hospital chains Health Management Associates ( HMA) and LifePoint ( LPNT) have suffered from misguided acquisitions.

Just this week, for example, HMA reported an 11% drop in earnings that could not be explained by the absence of year-ago insurance recoveries. Rather, same-hospital admissions slid during the quarter, while uninsured volumes rose, eating away at the industry-leading margins that the company has enjoyed for so long.

HMA once ranked as perhaps Wall Street's favorite hospital operator. However, the company has steadily lost support after straying from its rural hospital roots and acquiring high-priced facilities in larger markets in a tough industry environment.

By comparison, Community looks like a hospital company that knows exactly how to operate. Thus, even some cautious hospital analysts like the company whether it attracts a buyer or not.

"Community Health Systems is probably too richly valued for a buyout, but still remains undervalued, in our opinion," Stifel Nicolaus analyst Robert Hawkins wrote last week. Meanwhile, the company "should produce consistent results for the next few quarters, despite fundamental problems in the sector."

When launching coverage of the hospital industry this month, Hawkins portrayed Community as the "top operator" in the group. He has a buy recommendation and a $42 target price on the company's stock. His firm has no business relationship with the company.

Community's stock slid 2 cents to $37.11 on Tuesday. The shares posted industry-leading gains last year, peaking at $40.72 in December, but have failed to take part in any buyout-triggered rally.

History Lessons

Right now, hospital investors remain focused on the HCA story. They remember a struggling hospital chain that went private 17 years ago only to emerge as a much stronger public company, despite massive government scrutiny.

But Community has an impressive history of its own. Exactly 10 years ago, Community found itself scooped up by private equity investors as well. Back then, Modern Healthcare reported, Forstmann Little paid $1.4 billion for Community in its first health care venture and its biggest investment ever. The firm quickly hired two former Humana ( HUM) leaders, CEO Wayne Smith and CFO Larry Cash, to run the hospital chain.

In a 1997 interview with Health Systems Review, Smith portrayed Community as a "great niche business" that could evolve into a major rural hospital system over time.

"The backing of a company like Forstmann Little made it quite intriguing," Smith told the publication. "And quite frankly, the equity part of this was an important part of this as well. So it was professionally challenging, and hopefully it will be economically rewarding."

Community, regularly highlighted as one of Forstmann Little's best investments ever, went public again in 2000. The stock quickly attracted small-cap fund managers like Anthony Weber, who told Barron's that Community helped his firm post hefty gains while competitors fell with the rest of the market that year.

To be fair, the stock fared much worse in the years that followed. A $100 investment in Community at the end of 2000 wound up worth only $72.86 after one year and $58.83 after two. But the shares started to recover in 2003, when the rest of the industry faltered, regaining all of their lost ground -- and then some -- by the end of last year.

Today, Community boasts a market capitalization of $3.7 billion. Smith's 1.7% stake in the company is worth nearly $65 million. Smith last year collected $2.85 million in salary and bonuses to boot.

Performance and Pay

Excluding stock-option proceeds, payouts to leaders at other hospital companies -- with weaker operating results -- have come in at similar levels.

For example, Universal Health Services ( UHS) CEO Alan Miller raked in $3.73 million in salary and bonuses last year. Meanwhile, Triad ( TRI) CEO James Shelton pocketed $2.65 million of his own. Analysts have since highlighted both companies as likely takeout targets in the wake of the HCA buyout, due to their low share prices.

Universal stands out from the rest of the group because of its focus on behavioral health as well as acute-care facilities. Some experts believe that Universal could spin off its strong behavioral health unit, which has fared much better than its acute-care business, and unlock some extra value from both divisions in the process.

That said, Stephens analyst Nancy Weaver sees even greater payoffs for other companies under certain LBO scenarios. Notably, she feels that Triad could fetch a bigger premium than HCA did and, in fact, generate the most attractive returns of all.

She has warned investors against betting against the sector in the meantime.

"We believe that, over the next 12 to 18 months, someone will go private unless the group rallies," Weaver wrote last week, before the HCA deal became official. "We thus see the group as very dangerous to short."

Weaver's firm counts HCA as a major noninvestment banking client and hopes to secure investment banking business from the company as well over the next three months.

Meanwhile, investors could wait a long time for another buyout deal to come through. As a result, some experts feel, investors could be better served by investing in Community -- with its strong fundamentals -- instead.

"Since the company emerged from its leveraged buyout with Forstmann Little in 2000 as a public company, the company has been profitable and has met or exceeded consensus estimates," Hawkins reminded earlier this month. Moreover, "Community Health has one of the most seasoned hospital management teams, in our view. ... We believe that Community Health operates the most diligent, centralized and standardized operating plan of the publicly traded hospital chains."

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