Question Detail:
Merger Analysis Case Study
Merger Analysis Case Study
Franklin Teaching Hospital
Currently, three hospitals serve the patient base of Palmetto County, Florida, which has a population of about 220,000. The hospitals include the following:
Franklin Teaching Hospital, a 525-bed, not-for-profit university-related teaching hospital
Suncoast Regional Medical Center, a 200-bed, for-profit hospital owned by Senate Healthcare, a national chain
Palmetto General, a 400-bed, not-for-profit, acute care hospital owned by Citrus Healthcare
The service area has a total of 1,125 licensed beds for 200,000 people, or 5.1 beds per 1,000 people, which is higher than the national average of about 3.1 beds per 1,000 people, and much greater than 2 beds per 1,000 people needed under moderately aggressive utilization management. Of course, as a tertiary care facility, Franklin Teaching Hospital receives patients from throughout the state, but the bulk of its patients still come from the local five-county area.
Suncoast Regional Medical Center, a 200-bed, for-profit hospital owned by Senate Healthcare, a national chain
Palmetto General, a 400-bed, not-for-profit, acute care hospital owned by Citrus Healthcare
The service area has a total of 1,125 licensed beds for 200,000 people, or 5.1 beds per 1,000 people, which is higher than the national average of about 3.1 beds per 1,000 people, and much greater than 2 beds per 1,000 people needed under moderately aggressive utilization management. Of course, as a tertiary care facility, Franklin Teaching Hospital receives patients from throughout the state, but the bulk of its patients still come from the local five-county area.
With an excess capacity of hospital beds, the status quo may not survive the changing healthcare environment. Indeed, Palmetto General has had some tough years recently, as evidenced by its number of discharges, which have fallen to 11,412 in 2006 from 12,055 in 2005 and 12,824 in 2004. Additionally, Senate Healthcare has been aggressive in building market share in other areas of Florida through acquisitions. As a result of these factors the local hospital market is likely to witness some consolidation, and the most likely result is the acquisition of Palmetto General by either Franklin Teaching Hospital or Senate Healthcare.
Palmetto General operated as a county hospital for over 50 years and consequently developed a reputation for providing healthcare services to the poor. After many years of operating losses, the county concluded that it could no longer afford to operate the hospital. So, in 1983, the county sold the hospital to Citrus Healthcare, a not-for-profit managed care organization and provider, which by 2006 had become the state’s largest integrated healthcare company.
Citrus Healthcare’s major business line is managed care. Its numerous plans, including HMO (Health Maintenance Organization), PPO (Preferred Provider Organization), POS (Point of Service plans), Medicare, and Medicaid, serve over 400,000 members in 31 Florida counties, encompassing all of the major metropolitan areas. In addition to managed care plans, Citrus Healthcare owns nine different providers: two acute care hospitals including Palmetto General, two primary care hospitals, one rehabilitation hospital, one mental health facility, one hospice, one home healthcare provider, and one retirement facility.
Palmetto General is the flagship of Citrus Healthcare’s provider network and as such the company hlas maintained the hospital well in spite of falling inpatient utilization. In fact, in recent years, Palmetto General has built a new, state-of-the-art Heart Care Center and a modern Maternity Care Center. Furthermore, Palmetto General operates a full-service emergency department and a medical emergency helicopter service.
In response to the current situation, Franklin Teaching Hospital has formed a special committee to consider the feasibility of making an offer to Citrus Healthcare to acquire Palmetto General. The committee’s primary goals are as follows:
To place a dollar value on Palmetto General’s equity (fund) capital, assuming that the hospital will be acquired and operated by Franklin Teaching Hospital
To develop a financing plan for the acquisition
In addition, the committee has been asked to consider two other issues related to the potential acquisition.
To develop a financing plan for the acquisition
In addition, the committee has been asked to consider two other issues related to the potential acquisition.
What is the best organizational structure for a combined enterprise? Currently, both Palmetto General and Franklin Teaching Hospital have separate boards of directors and management staffs. Of course, the senior members of the board of Palmetto General currently are Citrus Healthcare officers.
Should the medical staffs of the two hospitals be integrated, and, if so, in what way? The medical staff of Palmetto General consists of local physicians, including many family practice physicians, while the medical staff at Franklin Teaching Hospital is almost entirely made up of specialists, and all are members of Franklin University’s College of Medicine with responsibilities that go well beyond clinical practice. A new committee will be formed to address the above issues should Franklin Teaching Hospital’s management agree to move forward with the acquisition offer, but some preliminary judgments are sought at this time.
As a starting point in the valuation analysis, the committee has obtained historical income statement and balance sheet data on both hospitals. Table 1 contains the data for Palmetto General, while Table 2 provides the data for Franklin Teaching Hospital. Note that both sets of statements focus on operating data, which are considered to be most relevant to the analysis. In addition, some relevant comparative data are presented in Table 3. Finally, relevant market data are contained in Table 4. (Note that the data in Tables 3 and 4 reflect late 2006 conditions.)
Should the medical staffs of the two hospitals be integrated, and, if so, in what way? The medical staff of Palmetto General consists of local physicians, including many family practice physicians, while the medical staff at Franklin Teaching Hospital is almost entirely made up of specialists, and all are members of Franklin University’s College of Medicine with responsibilities that go well beyond clinical practice. A new committee will be formed to address the above issues should Franklin Teaching Hospital’s management agree to move forward with the acquisition offer, but some preliminary judgments are sought at this time.
As a starting point in the valuation analysis, the committee has obtained historical income statement and balance sheet data on both hospitals. Table 1 contains the data for Palmetto General, while Table 2 provides the data for Franklin Teaching Hospital. Note that both sets of statements focus on operating data, which are considered to be most relevant to the analysis. In addition, some relevant comparative data are presented in Table 3. Finally, relevant market data are contained in Table 4. (Note that the data in Tables 3 and 4 reflect late 2006 conditions.)
One of the toughest tasks that the committee faces is the development of Palmetto General’s pro forma cash flow statements, which form the basis of a discounted cash flow valuation. Two basic questions must be answered before any numbers can be generated. First, what synergies, if any, can be realized from the merger and how long will it take for any synergies to be realized? For example, can duplications be eliminated? Both hospitals have mercy flight helicopters and both offer full emergency department services, even though the two hospitals are less than two miles apart. And, what is the impact of such operational changes on revenues and costs and hence on the net cash flows that Palmetto General’s assets can produce? Second, once the consolidation takes place and all synergies have been realized, what is the long-term growth prospect for Palmetto General’s cash flows? The answers to these questions, and others, form the basis for the pro forma cash flow estimates.
Assume that you are the chair of the special committee formed at Franklin Teaching Hospital to evaluate the potential acquisition. You must present your findings and recommendations to the hospital’s board of directors. Note that Tables 1 through 4 contain far less data than normally available to parties involved in merger analyses, especially when the potential merger is friendly. In effect, the case discussion and accompanying data raise many more questions than they answer. You will be required to make a myriad of difficult assumptions to complete the analysis. Although you do not know much about Palmetto General’s local market, you do know the current trends in the health services industry. Use this knowledge to help make judgments about the case. The quality of many, if not most, real-world financial analyses depend more on the validity of the underlying assumptions than on the theoretical correctness of the analytical techniques.
Note: There is no preferred solution to this case, so your case analysis will be judged as much on the assumptions used in the analysis as on the analysis itself. Finally, remember that numerous risk analysis techniques are available that can be used to give decision makers some feel for the risks involved.
Table 1: Palmetto General Hospital: Historical Financial Statements (in millions of dollars)
2002
2003
2004
2005
2006
Income Statements
Inpatient revenue
81.624
88.249
99.010
105.332
110.384
Outpatient revenue
22.861
27.067
34.628
43.616
50.810
Gross patient revenue
104.485
115.316
133.638
148.948
161.194
Allowances and discounts
33.699
38.626
44.622
51.198
62.006
Net patient revenue
70.786
76.690
89.016
97.750
99.188
Other operating revenue
1.922
1.515
1.367
1.725
1.048
Total operating revenue
72.708
78.205
90.383
99.475
100.236
Patients services expenses
60.245
73.858
81.525
90.645
89.505
Interest expense
3.045
3.147
3.093
3.002
2.980
Depreciation
3.466
3.689
4.395
4.258
6.031
Total operating expense
66.756
80.694
89.013
97.905
98.516
Net income
5.952
2.489
1.370
1.570
1.720
Balance sheets
Cash and investments
2.388
1.538
0.162
0.185
0.198
Accounts receivable
18.860
20.581
20.821
21.570
16.732
Other current assets
4.539
8.475
4.669
2.585
2.898
Total current assets
25.787
30.594
25.652
24.340
19.828
Gross plant and equipment
102.596
116.694
122.611
133.499
146.130
Accumulated depreciation
27.243
30.505
34.900
39.158
45.189
Net plant and equipment
75.353
86.189
87.711
94.341
100.941
Total assets
101.140
116.783
113.363
118.681
120.769
Current liabilities
9.182
13.584
5.771
10.689
11.431
Long-term debt
33.572
47.302
50.325
49.155
48.781
Total liabilities
42.754
60.886
56.096
59.844
60.212
Fund balance
58.386
55.897
57.267
58.837
60.557
Total claims
101.140
116.783
113.363
118.681
120.769
Table 2: Franklin Teaching Hospital: Historical Financial Statements (in millions of dollars)
2002
2003
2004
2005
2006
Income Statements
Inpatient revenue
238.510
287.559
328.047
363.236
398.997
Outpatient revenue
47.963
57.351
69.252
89.992
103.746
Gross patient revenue
286.473
344.910
397.299
453.228
502.743
Allowances and discounts
82.053
107.256
128.645
170.058
185.301
Net patient revenue
204.420
237.654
268.654
283.170
317.442
Other operating revenue
5.587
8.899
12.193
22.672
9.979
Total operating revenue
210.007
246.553
280.847
305.842
327.421
Patients services expenses
178.788
207.596
231.673
254.704
277.938
Interest expense
9.232
10.468
11.983
10.691
9.997
Depreciation
13.289
16.637
19.621
23.286
26.489
Total operating expense
201.309
234.701
263.277
288.681
314.424
Net income
8.698
11.852
17.570
17.161
12.997
Balance sheets
Cash and investments
17.918
19.862
24.660
27.726
25.220
Accounts receivable
66.212
72.989
99.867
100.297
97.494
Other current assets
12.315
16.771
20.741
20.542
22.757
Total current assets
96.445
109.622
145.268
148.565
145.471
Gross plant and equipment
348.288
341.064
335.313
362.152
400.546
Accumulated depreciation
75.139
76.575
90.056
109.468
123.567
Net plant and equipment
273.149
264.489
245.257
252.684
276.979
Total assets
369.594
374.111
390.525
401.249
422.450
Current liabilities
42.437
35.061
39.511
37.733
39.817
Long-term debt
146.997
147.038
141.432
136.773
142.893
Total liabilities
189.434
182.099
180.943
174.506
182.710
Fund balance
180.160
192.012
209.582
226.743
239.740
Total claims
369.594
374.111
390.525
401.249
422.450
Table 3: Selected Comparative Data
Palmetto
Franklin Teaching
Average age of plant
6.8 years
8.5 years
Licensed beds
400
525
Occupancy rate
52.7%
64.2%
Average length of stay
5.5 days
6.6 days
Number of discharges
11,412
19,748
Medicare percent
57.2%
29.7%
Medicaid percent
10.3%
13.0%
Medicare case mix index
1.51
2.13
Gross price per discharge
$11,688
$20,204
Net price per discharge
$5,850
$12,757
Cost per discharge
$5,703
$12,144
Table 4: U.S. Treasury Yield Curve
Maturity
Interest Rate
6 months
3.0
1 year
3.5
5 years
3.9
10 years
4.5
20 years
5.0
30 years
5.1
Market Risk Premium
Historical risk premium
7.0%
Average current risk premium as forecasted by three investment banking firms
6.0%
Market Betas, Capitalization, and Tax Rates of Two Publicly Traded Hospital Companies
Company
Beta
Debt/Asset Ratio
Tax Rate
Provident Healthcare
1.1
50%
40%
National Health Company
1.2
65%
43%
Ratio of Stock Price to EB1TDA per share
Provident Healthcare
6.1
National Health Company
7.9
Ratio of Total Equity Market Value to Number of Discharges
Provident Healthcare
$7000
National Health Company
$6000
Ratio of Total Equity Market Value to Number of Discharges
Large hospital average
5.0%
Note: The data in this table reflect assumptions to ease the case analysis, as opposed to actual data.
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