HMO Acquisition Shows There’s Still Big Money in Medicine : News analysis: Dozens would become multimillionaires in WellPoint-Health Systems deal. But a charitable group would benefit too.
The cost-cutting craze may be sweeping the health care world, with everyone from doctors to hospital administrators complaining about feeling squeezed.
But anyone who doubts there are still huge profits to be made in medicine need look only at the fortunes of several dozen people who would be made multimillionaires by the pending acquisition of Health Systems International by WellPoint Health Networks.
The $1.89-billion deal still requires regulatory and shareholder approval, but it is already clear that it would mean huge gains for Health Systems co-Chairmen and Chief Executives Roger F. Greaves and Malik M. Hasan, as well as many other current and former Health Systems executives.
Greaves and 32 fellow executives of Health Net--the corporate predecessor to Health Systems--bought 20% of the company for $1.5 million in 1992, when it converted from a not-for-profit health maintenance organization to a profit-making entity.
The takeover announced this week, in which WellPoint would acquire Health Systems for stock worth $1.89 billion, would boost the value of that stake to $209 million--a 13,833% gain.
Like the other original shareholders, Greaves is prohibited from selling his shares until 1997. But on paper, his personal stake will have grown from about $300,000 to $31.8 million.
“I’m very, very proud of what we’ve created here,” Greaves, who is leaving the company in the wake of the deal, said in an interview Tuesday. “We’ve put together two great things: a great health plan and the California Wellness Foundation,” a reference to the charity created when Health Net converted to for-profit status. “That the people who built this multimillion-dollar institution are compensated--that’s America.”
Also destined to reap a large gain is Hasan, a physician who was granted more than 5 million shares of Health Systems when his own Colorado-based HMO, QualMed, was absorbed by the company last year.
Hasan--who would remain as chairman of the newly merged entity and is Health Systems’ largest individual shareholder--would hold shares worth $175.9 million as a result of the deal.
The speed with which the market value of Health Systems has burgeoned raises questions about whether it was undervalued at the time of its conversion to for-profit status. The same issue has come to the fore across the nation as dozens of formerly nonprofit health maintenance organizations, hospitals and other health organizations have converted into profit-making companies.
In 1985, for example, executives of Loma Linda-based Inland Health Plan converted the organization to a profit-making entity, bought it for a price variously estimated at between $562,000 and $663,000--then sold it a year later to Aetna Life & Casualty Co. for $37.5 million.
Some experts say such radical undervaluations occurred because the profit-making entities were then so novel that no one knew how to appraise their prospects.
“There was no market value,” said Nancy Kane, a lecturer on management at the Harvard School of Public Health, “so they were valued at book value”--that is, the value of such hard assets as buildings and equipment.
Because health organizations are not typically capital-intensive--unlike, say, manufacturing companies--book value provided sharp underestimates of the institutions’ worth, especially once Wall Street realized that the new firms could be cash cows.
In part because conversions such as Inland’s raised complaints that the public was not gaining enough benefit from the health organizations’ years of tax-free status, state officials began requiring the new owners to make substantial donations to charity.
One of the models of that system is the California Wellness Foundation.
The foundation’s initial assets consisted of $300 million in cash and notes provided by Health Net and 80% of the stock of the new profit-making entity--non-voting stock at that. The Health Net holdings eventually became a 25-million-share stake in Health Systems.
That funding plan for the charity emerged only after months of controversy.
Health Net at first claimed to be worth only $108 million, but within months, outside bidders were offering $300 million to buy it. State Department of Corporations Commissioner Gary Mendoza accepted the higher price as Health Net’s fair value on the advice of Bear, Stearns & Co., the state’s financial advisers.
Now, some 2 1/2 years later, WellPoint is paying $1.89 billion for the company.
Still, many health care observers argue that the individual gains to be reaped in the WellPoint-Health Systems deal are balanced by the gains to the foundation. Its Health Systems holdings would be worth about $875 million.
“Public charity wouldn’t come out badly if this deal works,” John K. Van de Kamp, the former California attorney general who represents the foundation, said shortly before the agreement was announced.
Not only would the foundation’s net worth balloon, but with its equity stake, “we’d be holders in a stronger company,” Van de Kamp said.
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Healthy Rewards
Top executives of Health Systems International--who acquired most of their stock in the managed care company at a nominal cost when the firm converted to for-profit status in 1992--have holdings worth millions of dollars now that Health Systems will be acquired by WellPoint Health Networks. (The restricted shares cannot be sold till 1997, however.)
Value at Executive Title Shares Owned $35 a share Malik M. Hasan co-CEO 5,025,264 $175,884,240 Roger F. Greaves co-CEO 907,786 31,772,510 Stephen D. Vogt exec v.p. 484,199 16,946,965 Gerald M. Cooper exec v.p. 482,652 16,892,820
Note: Chart shows holdings as of June 24, 1994.
Source: Company reports
