Merger AnalysisMerger Analysis Case Study© 2007 South UniversityFr.docx
- 1. Merger AnalysisMerger Analysis Case Study© 2007 South UniversityFranklin Teaching HospitalEnter appropriate input values in the cells colored red.INPUT DATA:KEY OUTPUT:(millions of $)(millions of $)Cash flow data:Pro forma net cash flows:Growth in gross revenues (2007- 2011):2007$162.242Inpatient0.0%2008$162.242Outpatient0.0% 2009$162.242Allowances and discount %0.0%2010$162.242Other op rev growth rate0.0%2011$0.000Patient services exp as a% of net patient rev0.0%2007 EBITDA$162.242Percent of net op CFAverage 5- yr EBITDA$0.000retained for growth0.0%Annual inputs:*Interest on**Cost SavingsAcquisition value:YearRequired Loansat Franklin2007$0.000$0.000DCF method$0.0002008$0.000$0.000Market multiple method:2009$0.000$0.000Applied to 2000 EBITDA$0.0002010$0.000$0.000Applied to avg EBITDA$0.0002011$0.000$0.000Applied to discharges$0.000Long-term (2008 and beyond)constant growth rate0.0%*Interest on required loans represents theMarket data:estimated interest payments on any borrowingsDiscount rate (cost of equity)0.0%required to fund the acquisition.EBITDA multiple0.0Market value to discharges ratio$0**Cost savings at Franklin represents anysynergistic benefits that will accrue atOperating data:the acquirer as opposed to at the target.Expected number of discharges0HISTORICAL DATA:Palmetto General HospitalIncome Statements:(Millions of Dollars)20022003200420052006Inpatient revenue$81.624$88.249$99.010$105.332$110.384Outpatient revenue22.86127.06734.62843.61650.810Gross patient revenue$104.485$115.316$133.638$148.948$161.194Allowance s and discounts33.69938.62644.62251.19862.006Net patient revenue$70.786$76.690$89.016$97.750$99.188Other operating revenue1.9221.5151.3671.7251.048Total operating
- 2. revenue$72.708$78.205$90.383$99.475$100.236Patient services expenses$60.245$73.858$81.525$90.645$89.505Interest expense3.0453.1473.0933.0022.980Depreciation3.4663.6894.39 54.2586.031Total operating expense$66.756$80.694$89.013$97.905$98.516Net income$5.952($2.489)$1.370$1.570$1.720MODEL- GENERATED DATA:Palmetto General HospitalPro Forma Income Statements:(Millions of Dollars)20072008200920102011Inpatient revenue$110.384$110.384$110.384$110.384$110.384Outpatient revenue50.81050.81050.81050.81050.810Gross patient revenue$161.194$161.194$161.194$161.194$161.194Allowance s and discounts0.0000.0000.0000.0000.000Net patient revenue$161.194$161.194$161.194$161.194$161.194Other operating revenue1.0481.0481.0481.0481.048Total operating revenue$162.242$162.242$162.242$162.242$162.242Patient services expenses$0.000$0.000$0.000$0.000$0.000Interest expense0.0000.0000.0000.0000.000Total operating expense$0.000$0.000$0.000$0.000$0.000Net operating cash flow$162.242$162.242$162.242$162.242$162.242Cost savings at University0.0000.0000.0000.0000.000Growth retentions0.0000.0000.0000.0000.000Terminal value0.000Net cash flow to equityholders$162.242$162.242$162.242$162.242$0.000EBITD A$162.242$162.242$162.242$162.242$0.000Valuation Results:Average 5-year EBITDA$0.000Value according to DCF method$0.000Value according to market multiple method:Applied to 2004 EBITDA$0.000Applied to average 2004-2008 EBITDA$0.000 &A Page &P MHC6305 Financial Management of Healthcare Organizations
- 3. 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. 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
- 4. 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 has 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:
- 5. · 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. · 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.)
- 6. 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.
- 7. 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
- 8. 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
- 9. 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
- 10. 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
- 11. 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
- 12. 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
- 13. 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
- 14. 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
- 15. 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
- 16. 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
- 17. 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
- 18. 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
- 19. 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. Page 1 of 11 Week 3, Assignment 4 © 2007 South University