This deal has generated much more buzz than larger corporate takeovers (such as AT&T’s pending $88 billion purchase of BellSouth) because it’s the biggest going-private deal in history. The price–about $21.5 billion for HCA’s shareholders, plus the assumption of about $11.7 billion of debt–tops the legendary $31 billion “Barbarians at the Gates” buyout of RJR in 1989. That’s the deal in which Kohlberg Kravis Roberts & Co. won a spectacular bidding war that ended about the time the junk-bond market, which had provided cheap money for such deals, began melting down. KKR ran into major problems with RJR, and suffered huge hits to its reputation and to its investment record.
But now KKR and two other “private equity” firms–Bain & Co. and the private-equity arm of Merrill Lynch–are combining with HCA management and the company’s founding Frist family to do a deal that tops RJR. “If you live long enough, everything comes back,” says Ted Aronson of Aronson + Johnson + Ortiz, a Philadelphia money manager.
These going-private deals are back because private equity is hot. The reason: private-equity investments have produced consistent double-digit returns even though stocks are lower than they were in early 2000. There’s no exact definition of private equity, but as a rule, private-equity firms plunk money from big, sophisticated players into investments–such as the stock of the new HCA–that aren’t publicly traded. Private equity attracted $98 billion of investor cash in the first half of this year, according to Thomson Financial. That compares with $179 billion for all of last year–and less than $60 billion in 2003. As a result, private equity has accounted for 24 percent of the dollar value of U.S. corporate takeovers so far this year, up from just 8 percent in 2003. Richard Peterson, a senior researcher at Thomson, quips: “There’s nothing new under the sun except for a lot more zeros.”
Wall Street loves private equity because there are so many fees involved: fees for helping private-equity firms raise money, fees for helping them invest the money, fees for helping finance their deals. On HCA, the Street will probably get about half a billion dollars for helping to put the deal together and raising the $16 billion the new company will borrow to buy out its public shareholders. (The other $5.5 billion to do the deal is coming from the buyers.)
Shareholders get a premium $51 a share for their stock, which had been trading well below that before news of the deal leaked. But HCA’s managers and its founding Frists do better than anyone.
By my math, the Frists will swap their 4.4 percent stake in HCA for 12 percent of the new company plus $200 million of cash. How can this be? Watch. The Frists own about 16.9 million HCA shares, worth $860 million in the buyout. Their 12 percent stake in the new HCA will cost $660 million. But rather than forking over cash, they’ll surrender about 12.9 million shares, paying no tax on the difference between $660 million and the shares’ original cost, which is probably close to zero. They’ll still own about 4 million HCA shares, for which they’ll receive about $200 million, which would be subject to capital-gains tax. I ran this analysis past several parties to this deal, but no one would comment.
(An aside: Senate Majority Leader Bill Frist isn’t involved in this transaction, according to an aide who says that he’s sold all his HCA shares.)
The company’s management, which will trade $550 million worth of stock and stock options in return for a 10 percent stake in new company, gets a deal similar to the Frists’. They have a chance to become megarich if HCA goes public again within a few years, as the buyers intend. As a bonus, a private HCA won’t have to deal with Sarbanes-Oxley rules that affect public companies, and the managers won’t have to care what Wall Street thinks about anything. They’ve benefited already, because the same day that HCA unveiled the buyout, it reported second-quarter earnings below Wall Street estimates. Normally, HCA stock might have been clobbered. But with the buyout pending, the subpar profits didn’t matter.
Can private-equity firms continue producing outsize returns with so much money pouring in and interest rates rising? Probably not. But by the time that becomes obvious, return-hungry investors will be chasing a new fad. And Wall Street will still be collecting fees.
