HMO May Be in Shape to Go Public : Health Net: A strong stock market and demand for new issues mean that conditions are favorable for the company to sell shares.
Now that Health Net has completed its disputed conversion from a nonprofit to a for-profit health maintenance organization, where does the company go from here?
Don’t be surprised if Woodland Hills-based Health Net goes public before the year is out. The company--California’s second-largest HMO with nearly 900,000 members--says it has no immediate plans to sell stock to the public, but a key aim of its conversion was to give the HMO access to the financial markets, where it can raise capital for expansion.
And with the general strength of the stock market, demand for initial public offerings is particularly strong these days. Companies such as Health Net, knowing that they want a public stock sale at some point, could be compelled to strike now rather than wait a couple of years and risk trying to peddle their shares when investor demand for new issues has turned soft.
“It’s always very dicey to expect that the IPO market is going to hold up,” said Margo L. Vignola, who covers health-care stocks for Salomon Bros.
Moreover, HMO stocks have been among Wall Street’s favorites over the past two years--witness the gains in the shares of PacifiCare Health Systems Inc., United HealthCare Corp. and U. S. Healthcare Inc. That could give Health Net added incentive to sell stock now.
So too could Health Net’s present financial condition. Health Net earned $42.6 million on revenue of $886 million in 1990, but has not yet divulged its 1991 results. But company spokesman Jim Lucas said the HMO’s revenue topped $1 billion last year. As for its profit, Lucas would say only that “we had earnings that are consistent with our industry peers.” Translation: Its profit went up.
All of which means that Health Net “would be very attractive as an IPO candidate,” Vignola said.
What value might the market assign to Health Net? Todd B. Richter, a health-care analyst with Dean Witter Reynolds Inc., said “a very realistic” yet “conservative” gauge--based on the present stock prices of other big HMOs--would give Health Net a market valuation of roughly 16 times its annual earnings.
“Let’s assume in 1992 they can earn $60 million,” Richter said of Health Net. “After taxes, that’s about $40 million. And 16 times $40 million is $640 million.”
Health Net is also likely to sell stock rather than borrow money because it incurred $225 million of long-term debt as part of its conversion to a for-profit company. That debt will cost Health Net roughly $20 million in annual interest costs for at least the next two years, costs Lucas said are adequately covered by Health Net’s cash flow.
Roger F. Greaves, Health Net’s chairman, also has said the debt will have “no material effect” on its customers’ rates or service.
Last month, Health Net converted to for-profit status only after it spent nearly a year wrestling with the state Department of Corporations, consumer groups and several outside health-care companies over the terms of the conversion.
To convert, an HMO must donate an amount equal to its “fair market value” to charity. At one point, Health Net proposed donating $127 million and, in the second step of the deal, its management was going to buy ownership of the HMO for $1.5 million.
Consumer groups protested that the donation was too low and that management would get a huge company for a pittance. The outside health-care companies, meanwhile, made rival takeover bids, including one from Qual-Med Inc., a Colorado-based HMO operator that offered $300 million. All were rejected.
Finally on Feb. 6, state Corporations Commissioner Thomas Sayles announced an agreement between his office and Health Net. Health Net would immediately pay $75 million to a newly formed charitable foundation, called the California Wellness Foundation, and pay an additional $225 million plus interest to the foundation over the next 15 years.
Also, the plan allowed the Greaves-led Health Net management team to buy 20% of Health Net for $1.5 million and to get 100% of the company’s voting rights. The remaining 80% equity stake in Health Net was ceded to the foundation.
Sayles’ ruling also forbids Health Net’s executives from selling any of their stock for five years.
But if those terms were supposed to end the controversy about Health Net’s ownership, someone forgot to tell Qual-Med, which is about one-quarter Health Net’s size with 225,000 members.
Two weeks after Sayles’ decision, Qual-Med made a revised offer to buy Health Net, this time for $100 million. (It also would, of course, assume Health Net’s $225-million debt to the foundation.) Qual-Med also is in Superior Court in Sacramento, fighting to effectively overturn Sayles’ ruling and clear the way for its own offer. The next hearing on the company’s lawsuit is scheduled Thursday.
Health Net’s Lucas said “we don’t fully understand” Qual-Med’s new offer, and “we will study it more.” He declined comment on the lawsuit.
How can Qual-Med bid for Health Net when Health Net’s management is blocked from selling its 20% stake under Sayles’ order? Because, technically, management’s 20% stake is in Health Net’s new parent company HN Management Holdings Inc., and Qual-Med isn’t trying to buy HN Management, said J. Kevin Murphy, Qual-Med’s vice chairman.
Qual-Med wants to buy only Health Net’s operations, and “there’s no restriction whatsoever on that” involving management’s stock, Murphy said.
But Sayles noted that Health Net remains under the jurisdiction of his agency. Even assuming that Greaves and Health Net’s other directors agreed to Qual-Med’s offer, any change in Health Net’s ownership would first have to be approved by Sayles.
Sayles won’t speculate on deciding any future proposal. But he has said that if Health Net’s management makes a profit on its stock, such as by going public, that’s fine with him because it means that the charitable foundation’s investment will rise four times as much.
As he said when he approved Health Net’s conversion: “We want management to build shareholder value.”
