Dividend Delight

Dividend Delight

CHAIRMAN q&a by Jean Gruss | Editor/Lee-Collier

William Schoen led a deal to borrow $3.25 billion and give long-suffering shareholders a $2.4 billion dividend. Here's an inside look at why and how the deal came together.

William Schoen has been chairman of Health Management Associates for more than 20 years, but don't expect the 70-year-old executive to fade away.

In a bold move, Schoen fended off private-equity investors that have snapped up rival hospital companies, such as HCA last year, by using some of the same tactics. He engineered a deal to borrow $3.25 billion from Bank of America and handed shareholders $2.4 billion in the form of a one-time special cash dividend of $10 per share on March 1 (HMA's quarterly dividend was suspended indefinitely).

Schoen and HMA executives have long complained that their company's share price has sagged even as it has been one of the best-performing hospital companies in the country. With the dividend distribution and the lower stock price, they now hope investors will recognize the company's value and bid up the stock.

The massive deal chopped HMA's market value in half as shares reflected the dividend payment. The stock closed at $19.87 on March 1. On March 2, following the dividend distribution, the shares closed at $10.29. The stock price has since recovered and recently closed near $11 a share, reflecting a positive reception by investors.

According to the most recent securities filings, Schoen is a beneficial owner of about 6 million shares, a stake now valued at approximately $66 million after the dividend payout.

Schoen discussed the details of the deal with the Review the week before the March 1 dividend distribution:

Q: Take us inside the HMA boardroom. How did the deal come together?

A: First of all we recognized some time ago that we were not as leveraged as some of our competitors, even though our return on equity was better than anybody in this industry. From that standpoint, a lot of analysts and fund managers who own our stock talked to us about what their thoughts were with regards to our balance sheet. Having been around for some time and founding this company, I recognized what they were saying. There were a lot of different ways to leverage the company. So I led our board through several discussions over a long period of time with regards to our stock price and our balance sheet.

Our stock price over the last five years has not really had any major growth, even though our performance has continually improved on a per-share earnings basis. So we weren't being recognized to the extent we felt we should, which is a negative for our shareholders.

Naturally, after the HCA leveraged buyout (LBO), there were several buyout firms that contacted our company. Frankly, we talked to the board about this approach and I said to the board that I think we ought to look at all approaches. As you know, in a leverage buyout you give a small premium - and it has been a small premium - to the shareholders and they're basically out. And the management's position is normally very enhanced and naturally the equity buyers have been considerably enhanced. I know this because I took the company private in 1988 and took it public again in 1991. So from that standpoint, that was a small enhancement to our shareholders.

But then our shareholders would not participate in our growth in income, revenue and share price in the future. So we decided to review the options other than a leverage buyout that existed for our company. Our credit rating was very good, as you know. We have a long standing in this business that goes back 30 years. So there were really two approaches available to us other than an LBO.

One would be to go ahead and borrow money, but not to the extent of an LBO. What we decided to do is look at the approach of a Dutch auction and have a major share repurchase. The other option available to us was to go ahead and borrow the same amount of money and give a one-time cash dividend - approximately half of our market value - to our shareholders and keep the company public, continue to grow the company and not be restrained financially as we would have been in an LBO.

So it really boiled down to analyzing whether to pay a premium in a Dutch auction to basically remove half of the shares we have outstanding or give a cash dividend of approximately half our market value. So we then narrowed that down to looking at that as the best option, especially with cash dividends being taxed at a 15% rate. That is a very overriding interest to shareholders.

Q: Isn't a share buyback more tax-efficient than a dividend distribution?

A: No, because if people sell their stock they'll still have to pay capital-gains tax and that's 15%. The whole thing is that there's a window that allows the shareholder to take that cash dividend and buy a bigger piece of the company. Let's theoretically say somebody has 100 shares. They get the $10 cash dividend, they pay the 15% tax, they can almost double up with HMA shares and be in a position where they own a bigger share of the company.

We had no idea that Moody's would come out looking at this leverage with a [better-than-expected] Ba3 rating for our company. We were anticipating paying 250 basis points over LIBOR. The banks came back to us and said we can do that deal for 175 basis points over LIBOR. What it amounts to in general terms is that debt is less expensive than capital today. There haven't been windows like this in my past experience of investing for 50 years. We don't have any penalty to pay it off more quickly and cash flow in our industry is very good. So those all pointed to the advantage to our shareholders to give this cash dividend of half of our market value. Just by de-levering, we can show a 10% or more increase in our net earnings per year in our foreseeable future.

It's also a win for the company itself. It gives us great flexibility. Our cash flow is three times our interest. If the stock were to go down after we have this cash dividend, we have the ability to go ahead and purchase stock in the open market and not pay a premium.

Q: Did private equity firms make an offer to buy HMA?

A: The best way to put that is that we were in serious discussions. When it came to serious discussions, I recommended to the board that we look at all our alternatives. Again, the LBO would have been good for top management, including myself, and it would have enhanced our wealth. But the shareholders in my opinion would get the short end of the stick. This is much more advantageous to our shareholders.

Q: What should HMA's stock price be today?

A: We would think it should be anywhere north of $26, which is a 30% increase to what it is now. [Editor's note: Schoen was speaking about the stock price before the dividend distribution when it was trading at about $21.]

Q: HMA's stock fell after the announcement of the debt deal and subsequently recovered. What should we infer from that?

A: People didn't understand what we were doing. This is on the vanguard. There's nobody that I know of that's done this. It's a groundbreaking transaction.

Q: You've built this company into what it is today. How much of this decision was driven by your concern about what private equity firms would do to HMA if they were to acquire it?

A: The private equity investors who we've talked to would want me involved in the transaction and continue with the company. So that was something that I knew. Again, being a large shareholder myself, what is best for shareholders? This is also good for management because they'll be able to continue to grow the company and they'll be rewarded accordingly.

Q: When you speak with investors now, what is it that they're most concerned about?

A: The big investors did not understand our excess cash. So they were concerned that we could not continue to spend the money we do on capital expenditures or acquisitions. And we relieved them of that concern by our discussions with them.

Q: How much of a burden will HMA's debt expense be?

A: The IRS picks up part of this transaction. If our debt expense is around $220 million a year, the government will pick up $80 million of that. That's another advantage to this transaction. They're almost like our partners.

Q: How does that affect your ability to acquire new hospitals?

A: Our mandatory reduction of principal on this loan per year is only 1%. That's only $27 million. So we have a lot of excess cash flow to be able to buy hospitals. Plus, we have a $500 million line of credit that's not pulled down at all. So it's all very positive.

Q: Are you considering the sale of any of HMA's hospitals?

A: We have a contract now on two of our hospitals. We sold three psych facilities. We did not want to be in the psychiatric business. We have a third held for divestiture. As we look at our portfolio, any hospital that doesn't meet our criteria we would naturally take a look at for sale.

Q: What is the outlook for caring for indigents?

A: There is a move afoot both in the states and in the federal government to cover the uninsured. We're very optimistic that this new Congress will put forth some solutions to the uninsured. So that's positive.

Q: Some executives complain about the burdens associated with running a public company. What is your opinion?

A: With this size company you're going to have Sarbanes-Oxley anyway if we were private. So, there is no advantage. You have to comply with the regulations of the states and the federal government. There is no advantage in my opinion of being a private company our size as compared to being a public company. If we had gone to an LBO, we would have public debt outstanding. Right now, this is all private debt. We would have to do all that Sarbanes-Oxley with that public debt that you would with stock. People who think there's an advantage haven't read the rules and regulations.

Q: Do you plan to reinstate the quarterly dividend one day?

A: That would be up to the board of directors.

REVIEW SUMMARY

Industry. Hospitals

Who. William Schoen

Key. Health Management Associates takes advantage of cheap debt markets to boost shareholder value.