HCA's LBO Represents a High-Risk Bet on Growth

question 121

Essay

HCA's LBO Represents a High-Risk Bet on Growth
While most LBOs are predicated on improving operating performance through a combination of aggressive cost cutting and revenue growth, HCA laid out an unconventional approach in its effort to take the firm private. On July 24, 2006, management again announced that it would "go private" in a deal valued at $33 billion including the assumption of $11.7 billion in existing debt.
The approximate $21.3 billion purchase price for HCA's stock was financed by a combination of $12.8 billion in senior secured term loans of varying maturities and an estimated $8.5 billion in cash provided by Bain Capital, Merrill Lynch Global Private Equity, and Kohlberg Kravis Roberts & Company. HCA also would take out a $4 billion revolving credit line to satisfy immediate working capital requirements. The firm publicly announced a strategy of improving performance through growth rather than through cost cutting. HCA's network of 182 hospitals and 94 surgery centers is expected to benefit from an aging U.S. population and the resulting increase in health-care spending. The deal also seems to be partly contingent on the government assuming a larger share of health-care costs in the future. Finally, with many nonprofit hospitals faltering financially, HCA may be able to acquire them inexpensively.
While the longer-term trends in the health-care industry are unmistakable, shorter-term developments appear troublesome, including sluggish hospital admissions, more uninsured patients, and higher bad debt expenses. Moreover, with Medicare and Medicaid financially insolvent, it is unclear if future increases in government health-care spending would be sufficient to enable HCA investors to achieve their expected financial returns. With the highest operating profit margins in the industry, it is uncertain if HCA's cash flows could be significantly improved by cost cutting, if the revenue growth assumptions fail to materialize. HCA's management and equity investors have put themselves in a position in which they seem to have relatively little influence over the factors that directly affect the firm's future cash flows.
-Having pledged not to engage in aggressive cost cutting, how do you think HCA and its financial sponsor group planned on paying off the loans?