The Affordable Care Act is all set to come into force from January 2014. The law ensures that hard working, middle class families get the security they deserve by making health insurance a compulsion while at the same time, protecting Americans from the worst insurance company abuses by restricting them from charging higher premiums.
Foreseeing the immediate rise in demand for hospital services after the Act becomes effective, hospitals are acquiring rivals to enhance their operational capacity. Recently, Community Health Systems (NYSE:CYH) acquired Health Management Associates Inc (NYSE:HMA) as the company prepares for the introduction of Obamacare.
The synergies expected from the acquisition of Health Management Associates Inc (NYSE:HMA)
The recent merger of the two hospitals will result in the largest for-profit hospital system in the United States. Despite the potential synergy that Health Management Associates Inc (NYSE:HMA) can offer, it was acquired at a 7.6% discount.
The acquisition of Health Management Associates Inc (NYSE:HMA) is highly complementary for Community Health Systems (NYSE:CYH) as it expands the hospital’s geographic reach and provides the hospital an opportunity to reap the benefits from the upcoming healthcare reforms. Once the deal receives the regulatory approval, Community Health Systems (NYSE:CYH) will operate nearly 206 hospitals across 29 states, with a total bed count of 30,896 and 1,000 clinics.
It is expected that around 14 million new patients will be insured in 2014. This will provide the combined company an opportunity to cater to this rising demand as both the hospitals are currently operating below their full operational capacity. Community Health Systems (NYSE:CYH) had an occupancy rate of 36.9% while Health Management Associates Inc (NYSE:HMA) reported an occupancy rate of 48.6% for the fiscal year 2012. This will bring in higher revenue for the hospitals.
However, in the face of rising demand, the major concern that comes to mind is the limited number of physicians available. The rising demand could strengthen the bargaining power of physicians, leading to higher operating costs for hospitals. This could potentially squeeze their profit margins. This explains the reason behind the discounted price paid for this merger.
Also, the increased scale of operations could result in lower costs of operations and administration. Community Health Systems (NYSE:CYH) Health anticipates the merger to have a neutral impact on its earnings per share in 2013, while being significantly accretive to earnings 2014 onward.
The hospital entered into a loan commitment of $6.8 billion in order to fund its purchase of Health Management Associates Inc (NYSE:HMA).
The company looks forward to repaying this debt from its operating cash flow. The pre-acquisition debt-to-equity ratio of Community Health Systems (NYSE:CYH) stood at 3.3 times. The post-acquisition ratio has risen to 5.6 times. It may seem to be an alarming situation to many, but with the current borrowing rates at record low levels, it may be better than tying up the company’s own cash. The cost of equity is usually more than the prevailing interest rates.
The market moves by other competitors
LifePoint Hospitals (NASDAQ:LPNT) is also a key player in the hospital industry and operates general acute care hospitals. It operates 56 hospital campuses across 20 states with a total of approximately 6,581 licensed beds as of December 2012.
The hospital deal pipeline remains active as stand alone hospitals and small chains are under constant pressure and looking forward to sell themselves to larger-scale hospitals. Recently, LifePoint Hospitals (NASDAQ:LPNT) acquired Bell Hospitals which is a 25-bed critical access hospital serving the healthcare needs of people throughout Marquette County. The hospital had reported revenue of around $40 million with a net operating loss in the previous year. This deal is likely to add very little value to the company’s per share earnings.
LifePoint Hospitals (NASDAQ:LPNT)’s revenue has grown at a CAGR of 16.13% over the last three years, which is a lot higher than the industry average of 9.3%. However, due to the hospital’s other operating expenses, its net profit was only able to grow at a CAGR of 4.29% as compared to the industry average of 8.8%. This could be a concern for shareholders as they were unable to reap the benefits of the hospital’s superior top-line growth.
The hospital is also slightly undervalued based on its P/E (ttm) which stands at 20.8x as compared to the industry average of 21.7x.
Community Health has a bright outlook in the midst of rising demand for its hospital services despite a few concerns that may hinder the company’s performance. LifePoint Hospitals (NASDAQ:LPNT) does not seem to be in a strong position to take advantage of the changing health laws. The recent acquisition is also less likely to add much value to the hospital. Its return on equity (ttm) also stands at a low 5.5% as compared to the industry average of 17.9%. In my opinion, this stock is a sell candidate.
Awais Iqbal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Awais is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Make Healthy Profits From This Healthcare Company originally appeared on Fool.com is written by Awais Iqbal.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.