March 18, 2011, 4:11 pm



HCA - HCA Holdings plans on offering 142.6 million shares (assuming over-allotments) at a range of $27-$30. Insiders will be selling 36.3 million shares in the deal. BofA Merrill Lynch, Citi and JP Morgan are leading the deal, Barclays, Credit Suisse, Deutsche Bank, Morgan Stanley, Wells Fargo, Credit Agricole, Mizuho, RBC, RBS, SMBC Nikko, Suntrust, Avondale, Baird, Cowen, Susquehanna, Raymond James, Lazard, Morgan Keegan and CRT are all co-managing. Post-ipo HCA will have 533.8 million shares outstanding for a market cap of $15.213 billion on a pricing of $28.50. Ipo proceeds will be used to repay debt.

Hercules Holding will own 70% of HCA post-ipo. Hercules Holdings consists of Bain Capital, Kohlberg Kravis Roberts, Citigroup, BofA and Merrill Lynch Global Private Equity (now BAML Capital Partners) as well as HCA's founder. The private equity groups purchased HCA in 11/06 for approximately $33 billion. Of that total, just $5.3 million was cash from the private equity conglomerate. Counting dividends paid in 2010, the shares being sold on ipo (Hercules is the inside seller) and the 70% post-ipo stake, the private equity group will have approximately tripled their investment (assuming a $28.50 pricing). Another cash grab from private equity funds via a leverage buyout.

Post-ipo HCA will be swathed in debt to the tune of $26 billion, nearly all of which was placed here in the 2006 LBO. These deals always tend to leave a sour taste in my mouth for one big reason - When one entity profits massively in a deal coming public by laying debt onto the public entity, buyer beware. We've seen these heavily in debt LBO deals work if priced properly, we'll attempt to discern if this deal is coming public attractively....while always keeping the massive debtload in the forefront.

From the prospectus:

'We are the largest non-governmental hospital operator in the U.S. and a leading comprehensive, integrated provider of health care and related services.'

Acute care hospitals, outpatient facilities, clinics and other patient care delivery settings.

164 hospitals with 41,000 beds and 106 surgery centers in 20 states throughout US and England. Most located in the South, HCA derives nearly half their revenues in Texas and Florida.

Very simple deal for such a large company: Largest non-government hospital group in the US coming public highly leveraged due to a private equity LBO 5 years prior. One very big positive - largest hospital group, one very big negative - $26 billion in debt post-ipo.

Sector - Aging US population driving hospital stay and surgical center traffic. Those aged 65+ in the US will grow 3% annually over the next 20 years and constitute 19% of the population by 2030.

Impact of health reform law - Although significant reductions in Medicare program payments are expected, HCA believes the expansion in the number of those covered could potentially lead to larger private/government program payments combined. Short term however, HCA believes the Health Reform Law will negatively impact per patient government program reimbursement.

Performance - For the 12 months ended 3/31/10, HCA's hospitals achieved a score of 98.4% of the CMS core measures, compared to 95.3% national average.

No single facility contributes more than 2.3% of revenues and no metro area more than 8%. 3000 managed care contracts with no single commercial payer representing more than 8% of revenues.

Outpatient services account for 38% of revenues.

20,523 average daily patient census across HCA's network. 5.7 million emergency room visits in 2010, a strong growth niche for HCA. 1.25 million surgeries in 2010.

***Debt has remained on the books as HCA has funneled $7.5 million in cash flows past five years into facility upgrades and technology systems. Note that it appears HCA has only been using net cash flows to funnel into upgrades and technology systems.

Growth plans - Debt is going to hamper growth. Cash flows here are strong, HCA may be best served funneling a portion of future cash flows towards paying down some of that $26 billion in debt. Internally, HCA does plan on expanding in existing hospitals by offering additional services such as cardiology, emergency, oncology and women's. Another expected growth spot includes continuing to beef up outpatient services. Looks as if HCA is not looking at additional hospitals, but rather to continue to grow existing facilities and branching those facilities out.


$26 billion in net debt.

HCA will not pay dividends.

41% of revenues from Medicare and Medicaid programs. Managed care plans account for 54% of revenues.

***Whenever dealing with Medicare/Medicaid, the shifts in payments and forecasts are ever changing. We won't try to delve into the risks here, HCA themselves note that at this point even they do not know the potential impact of the Health Reform Act. Page after page of the prospectus is filled with notes on potential changes in Medicare/Medicaid. We however are traders/investors and not healthcare attorneys. Our takeaway on operations is this: HCA appears to be a very well run hospital network that has improved payment systems and operational efficiencies over the past few years. Well run outfit that should be able to manage as best they can whatever Medicare/Medicaid and the Health Reform Act throw at them.

2010 - After 5%-7% revenues growth in 2007, 2008 and 2009, revenues grew only 2% in 2010. Revenues were $30.7 billion. Operating margins of 27%. Plugging in doubtful accounts/depreciation/pro-forma debt servicing (taking into account debt paid off on ipo), pre-tax margins of 8%.

Note that debt servicing eats into 46% of pre-tax profits. This is substantial, and with the lack of overall growth means the PE level here needs to be pretty low for this deal to work.

Plugging in taxes, net margins of 5.1%. EPS of $2.25. On a pricing of $28.50, HCA would trade at a trailing PE of just over 12 1/2.

2011 - With the state/federal tightening on Medicaid/Medicare growth, another 2%-3% top-line year should be the expectation. Competitors are generally looking for 4%-6% growth, so we will bump up HCA to 4%. Margins should improve slightly, although we should note that in 2010 salaries/benefits increased on nearly 1:1 ratio to revenue growth. On a revenue run rate of $31.8 billion and net margins of 5.3%, HCA would earn $2.55-$2.60. On a pricing of $28, HCA would trade 11 X's 2011 estimates.

Note that annually, HCA books over $1 billion in free cash flow after debt servicing.

A quick look at US competition. Keep in mind HCA is easily the largest comp in this group.

THC: $3.5 billion cap, trading 20 X's 2011 estimates. $4 billion in debt.

UHS: $4.64 billion cap, trading 13 X's 2011 estimates. $4 billion in debt.

CYH: $3.83 billion cap, trading 12 1/2 X's 2011 estimates. $9 billion in debt.

LPNT: $2 billion cap, trading 13 X's 2011 estimates. $1.6 billion in debt.

HMA: $2.56 billion cap, trading 13 1/2 X's 2011 estimates. $3.25 billion in debt.

Yep, a heavily leveraged sector with all players growing about the same 4%-6% in 2011 and trading in a tight PE range. With so much of the business under government payment programs, very difficult to stand out and 'build a better mousetrap'. Result is that the valuations, balance sheets and growth all look about the same.

HCA: $15.23 billion cap on a pricing of $28. Would trade 11 X's 2011 estimates. $26 billion in debt.

Conclusion - Looks to me as if the underwriting team and PE firms are bringing this bloated LBO flipback to the market pretty attractively valued. Yes the debt is massive, which is reason enough not to get too excited here. However HCA is the leader in this space and from all indications very well-managed. $7.5 billion in free cash flows have been invested back into the hospitals the past five years on improvements, upgrades, and technology. Now it is time to take a chunk of that $1+ billion a year in free cash flows and pay off some debt. If they do so, the range here should work well mid-term+. Short term slight recommend here, longer term if HCA continues operating efficiencies and pays down cash this deal should be a success. Not one to pay up for (unless for a flip), but one being attractively priced in range vis a vis peer group.

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