homework

You are to evaluate a potential acquisition and make a recommendation. Download and read the

scenario

. Download and use the

spreadsheet

for analysis.

Present your analysis as a 3-page report in a Word document formatted in APA style.

Name your document LastnameFirstInitial_W3_A4 .For example, if your name is John Smith, your document will be named SmithJ_W3_A4 .

By Wednesday, October 2, 2013, submit your report to the W3: Assignment 4 Dropbox.

Assignment 4 Grading Criteria	Maximum Points
Analyzed qualitative and quantitative information in the case study, applying correct reasoning.
Performed necessary calculations and presented results in appropriate formats.
Interpreted results of the qualitative and quantitative analysis.
Formulated and justified recommendations or conclusions based on the interpretation of results.
Presented case analysis expressing ideas clearly, using appropriate transitions and headings.
Applied the correct APA style, usage, grammar, and punctuation.
Total

Merger Analysis

South University

(millions of $)

–

2007

$162.242

0.0%

$162.242

0.0%

$162.242

0.0% 2011

.000

0.0%

$162.242

0.0%

2007

$0.000

2008 $0.000 $0.000

2009 $0.000 $0.000

$0.000

2010 $0.000 $0.000

$0.000

2011 $0.000 $0.000

$0.000

0.0%

0.0

Palmetto General Hospital

(Millions of Dollars)

2007 2008 2009 2010 2011
Inpatient revenue $110.384 $110.384 $110.384 $110.384 $110.384
Outpatient revenue 50.810 50.810 50.810 50.810 50.810
Gross patient revenue $161.194 $161.194 $161.194 $161.194 $161.194
Allowances and discounts 0.000 0.000 0.000 0.000 0.000
Net patient revenue $161.194 $161.194 $161.194 $161.194 $161.194
Other operating revenue 1.048 1.048 1.048 1.048 1.048
Total operating revenue $162.242 $162.242 $162.242 $162.242 $162.242
Patient services expenses $0.000 $0.000 $0.000 $0.000 $0.000
Interest expense 0.000 0.000 0.000 0.000 0.000
Total operating expense $0.000 $0.000 $0.000 $0.000 $0.000

$162.242 $162.242 $162.242 $162.242 $162.242

0.000 0.000 0.000 0.000 0.000

0.000

$162.242 $162.242 $162.242 $162.242 $0.000

EBITDA $162.242 $162.242 $162.242 $162.242 $0.000

$0.000

															Merger Analysis Case Study	©	2	0
Franklin Teaching Hospital
Enter appropriate input values in the cells colored red.
INPUT DATA:	KEY OUTPUT:
	(millions of $)
Cash flow data:	Pro forma net cash flows:
Growth in gross revenues (	2007			2011										$162.242
Inpatient							0.0		2008
Outpatient			2009
Allowances and discount %			2010
Other op rev growth rate												$0
Patient services exp as a
% of net patient rev	2007	EBITDA
Percent of net op CF	Average 5-yr EBITDA												0.000
retained for growth
Annual inputs:
*Interest on	**Cost Savings	Acquisition value:
Year	Required Loans	at Franklin
										$0.000	DCF method
Market multiple method:
Applied to 2000 EBITDA
Applied to avg EBITDA
Applied to discharges
Long-term (2008 and beyond)
constant growth rate
*Interest on required loans represents the
Market data:	estimated interest payments on any borrowings
Discount rate (cost of equity)	required to fund the acquisition.
EBITDA multiple
Market value to discharges ratio	**Cost savings at Franklin represents any
synergistic benefits that will accrue at
Operating data:	the acquirer as opposed to at the target.
Expected number of discharges
HISTORICAL DATA:
	Palmetto General Hospital
Income Statements:
	(Millions of Dollars)
2002	2003	2004	2005	2006
	Inpatient revenue	$81.624	$88.249	$99.010	$105.332			$110.384
	Outpatient revenue	22.861	27.067	34.628	43.616			50.810
	Gross patient revenue	$104.485	$115.316	$133.638	$148.948						$161.194
	Allowances and discounts	33.699	38.626	44.622	51.198	62.006
	Net patient revenue	$70.786	$76.690	$89.016	$97.750	$99.188
	Other operating revenue	1.922	1.515	1.367	1.725			1.048
	Total operating revenue	$72.708	$78.205	$90.383	$99.475	$100.236
	Patient services expenses	$60.245	$73.858	$81.525	$90.645	$89.505
	Interest expense	3.045	3.147	3.093	3.002	2.980
Depreciation	3.466	3.689	4.395	4.258	6.031
	Total operating expense	$66.756	$80.694	$89.013	$97.905	$98.516
Net income	$5.952	($2.489)	$1.370	$1.570	$1.720
MODEL-GENERATED DATA:
Pro Forma Income Statements:
Net operating cash flow
Cost savings at University
Growth retentions
Terminal value
Net cash flow to equityholders
Valuation Results:
Average 5-year EBITDA
Value according to DCF method
Value according to market multiple method:
Applied to 2004 EBITDA
Applied to average 2004-2008 EBITDA

&A
Page &P

MHC6305 Financial Management of Healthcare Organizations

Merger Analysis Case Study

Franklin Teaching

Hospital

Currently, three hospitals serve the patient base of

Palmetto

County, Florida, which has a population of about 220,000. The hospitals include the following:

· Franklin Teaching Hospital, a

525

-bed, not-for-profit university-related teaching hospital

· Suncoast Regional Medical Center, a 200-bed, for-profit hospital owned by Senate Healthcare, a national chain

· Palmetto General, a

400

-bed, not-for-profit, acute care hospital owned by Citrus Healthcare

The service area has a total of 1,125 licensed beds for 200,000 people, or

5.1

beds per 1,000 people, which is higher than the national average of about 3.1 beds per 1,000 people, and much greater than 2 beds per 1,000 people needed under moderately aggressive utilization management. Of course, as a tertiary care facility, Franklin Teaching Hospital receives patients from throughout the state, but the bulk of its patients still come from the local five-county area.

With an excess capacity of hospital beds, the status quo may not survive the changing healthcare environment. Indeed, Palmetto General has had some tough years recently, as evidenced by its number of discharges, which have fallen to

11,412

2006

from 12,055 in

2005

and 12,824 in

2004

. Additionally, Senate Healthcare has been aggressive in building market share in other areas of Florida through acquisitions. As a result of these factors the local hospital market is likely to witness some consolidation, and the most likely result is the acquisition of Palmetto General by either Franklin Teaching Hospital or Senate Healthcare.

Palmetto General operated as a county hospital for over 50 years and consequently developed a reputation for providing healthcare services to the poor. After many years of operating losses, the county concluded that it could no longer afford to operate the hospital. So, in 1983, the county sold the hospital to Citrus Healthcare, a not-for-profit managed care organization and provider, which by 2006 had become the state’s largest integrated healthcare company.

Citrus Healthcare’s major business line is managed care. Its numerous plans, including HMO (Health Maintenance Organization), PPO (Preferred Provider Organization), POS (Point of Service plans), Medicare, and Medicaid, serve over 400,000 members in 31 Florida counties, encompassing all of the major metropolitan areas. In addition to managed care plans, Citrus Healthcare owns nine different providers: two acute care hospitals including Palmetto General, two primary care hospitals, one rehabilitation hospital, one mental health facility, one hospice, one home healthcare provider, and one retirement facility.

Palmetto General is the flagship of Citrus Healthcare’s provider network and as such the company has maintained the hospital well in spite of falling inpatient utilization. In fact, in recent years, Palmetto General has built a new, state-of-the-art Heart Care Center and a modern Maternity Care Center. Furthermore, Palmetto General operates a full-service emergency department and a medical emergency helicopter service.

In response to the current situation, Franklin Teaching Hospital has formed a special committee to consider the feasibility of making an offer to Citrus Healthcare to acquire Palmetto General. The committee’s primary goals are as follows:

· To place a dollar value on Palmetto General’s equity (fund) capital, assuming that the hospital will be acquired and operated by Franklin Teaching Hospital

· To develop a financing plan for the acquisition

In addition, the committee has been asked to consider two other issues related to the potential acquisition.

· What is the best organizational structure for a combined enterprise? Currently, both Palmetto General and Franklin Teaching Hospital have separate boards of directors and management staffs. Of course, the senior members of the board of Palmetto General currently are Citrus Healthcare officers.

· Should the medical staffs of the two hospitals be integrated, and, if so, in what way? The medical staff of Palmetto General consists of local physicians, including many family practice physicians, while the medical staff at Franklin Teaching Hospital is almost entirely made up of specialists, and all are members of Franklin University’s College of Medicine with responsibilities that go well beyond clinical practice. A new committee will be formed to address the above issues should Franklin Teaching Hospital’s management agree to move forward with the acquisition offer, but some preliminary judgments are sought at this time.

As a starting point in the valuation analysis, the committee has obtained historical income statement and balance sheet data on both hospitals. Table 1 contains the data for Palmetto General, while Table 2 provides the data for Franklin Teaching Hospital. Note that both sets of statements focus on operating data, which are considered to be most relevant to the analysis. In addition, some relevant comparative data are presented in Table 3. Finally, relevant market data are contained in Table 4. (Note that the data in Tables 3 and 4 reflect late 2006 conditions.)

One of the toughest tasks that the committee faces is the development of Palmetto General’s pro forma cash flow statements, which form the basis of a discounted cash flow valuation. Two basic questions must be answered before any numbers can be generated. First, what synergies, if any, can be realized from the merger and how long will it take for any synergies to be realized? For example, can duplications be eliminated? Both hospitals have mercy flight helicopters and both offer full emergency department services, even though the two hospitals are less than two miles apart. And, what is the impact of such operational changes on revenues and costs and hence on the net cash flows that Palmetto General’s assets can produce? Second, once the consolidation takes place and all synergies have been realized, what is the long-term growth prospect for Palmetto General’s cash flows? The answers to these questions, and others, form the basis for the pro forma cash flow estimates.

Assume that you are the chair of the special committee formed at Franklin Teaching Hospital to evaluate the potential acquisition. You must present your findings and recommendations to the hospital’s board of directors. Note that Tables 1 through 4 contain far less data than normally available to parties involved in merger analyses, especially when the potential merger is friendly. In effect, the case discussion and accompanying data raise many more questions than they answer. You will be required to make a myriad of difficult assumptions to complete the analysis. Although you do not know much about Palmetto General’s local market, you do know the current trends in the health services industry. Use this knowledge to help make judgments about the case. The quality of many, if not most, real-world financial analyses depend more on the validity of the underlying assumptions than on the theoretical correctness of the analytical techniques.

Note: There is no preferred solution to this case, so your case analysis will be judged as much on the assumptions used in the analysis as on the analysis itself. Finally, remember that numerous risk analysis techniques are available that can be used to give decision makers some feel for the risks involved.

101.140

116.783

113.363

118.681

120.769

Table 1: Palmetto General Hospital: Historical Financial Statements (in millions of dollars)
	2002		2003		2004		2005	2006
	Income Statements
	Inpatient revenue	81.624	88.249	99.010	105.332	110.384
	Outpatient revenue	22.861	27.067	34.628	43.616	50.810
	Gross patient revenue	104.485	115.316	133.638	148.948	16 1.1 94
	Allowances and discounts	33.699	38.626	44.622	51.198	62.006
	Net patient revenue	70.786	76.690	89.016	97.750	99.188
	Other operating revenue	1.922	1.51 5	1.367	1.725	1.048
	Total operating revenue	72.708	78.205	90.383	99.475	100.236
	Patients services expenses	60.245	73.858	81.525	90.645	89.505
	Interest expense	3.0 45	3.147	3.093	3.002	2.980
	Depreciation	3.466	3.689	4.395	4.258	6.031
	Total operating expense	66.756	80.694	89.013	9 7.9 05	98.516
	Net income	5.952	2.489	1.370	1.570	1.720
	Balance sheets
	Cash and investments	2.388	1.538	0.162	0.185	0.198
	Accounts receivable	18.860	20.581	20.821	21.570	16.732
	Other current assets	4.5 39	8.475	4.669	2.585	2.898
	Total current assets	25.787	30.594	25.652	24.340	19.828
	Gross plant and equipment	102.596	116.694	122.611	133.499	14 6.1 30
	Accumulated depreciation	27.243	30.505	34.900	39.158	45.189
	Net plant and equipment	75.353	86.189	87.711	94.341	100.941
	Total assets		101.140		116.783		113.363	118.681	120.769
	Current liabilities	9.182	1 3.5 84	5.771	10.689	11.431
	Long-term debt	33.572	47.302	50.325	49.155	48.781
	Total liabilities	42.754	60.886	56.096	59.844	60.212
	Fund balance	58.386	55.897	57.267	58.837	60.557
	Total claims

2002

2003

2004

2005

2006

Income Statements

Inpatient revenue

Outpatient revenue

Gross patient revenue

Allowances and discounts

Net patient revenue

Other operating revenue

Total operating revenue

Patients services expenses

Interest expense

Depreciation

Total operating expense

Net income

Balance sheets

Cash and investments

Accounts receivable

Other current assets

Total current assets

Gross plant and equipment

Accumulated depreciation

Net plant and equipment

Total assets

Current liabilities

Long-term debt

Total liabilities

Fund balance

Total claims

369.594

374.111

390.525

401.249

422.450

Table 2: Franklin Teaching Hospital: Historical Financial Statements (in millions of dollars)
238.510	287.559	328.047	363.236	398.997
47.963	57.351	69.252	89.992	103.746
286.473	344.910	397.299	453.228	502.743
82.053	107.256	128.645	170.058	185.301
204.420	237.654	268.654	283.170	317.442
5.587	8.899	12.193	22.672	9.979
210.007	246.553	280.847	305.842	327.421
178.788	207.596	231.673	254.704	277.938
9.232	10.468	11.983	10.691	9.997
13.289	16.637	19.621	23.286	26.489
201.309	234.701	263.277	288.681	314.424
8.698	11.852	17.570	17.161	12.997
17.918	19.862	24.660	27.726	25.220
66.212	72.989	99.867	100.297	97.494
12.315	16.771	20.741	20.542	22.757
96.445	109.622	145.268	148.565	145.471
348.288	341.064	335.313	362.152	400.546
75.139	76.575	90.056	109.468	123.567
273.149	264.489	245.257	252.684	276.979
	369.594		374.111		390.525	40 1.2 49	422.450
42.437	3 5.0 61	39.511	37.733	39.817
146.997	147.038	141.432	136.773	142.893
189.434	182.099	180.943	174.506	182.710
180.160	192.012	209.582	226.743	239.740

Table 3: Selected Comparative Data
Palmetto	Franklin Teaching
Average age of plant	6.8 years	8. 5 years
Licensed beds	400	525
Occupancy rate	52.7%	64.2%
Average length of stay	5.5 days	6.6 days
Number of discharges	11,412	19,748
Medicare percent	57.2%	29.7%
Medicaid percent	10.3%	13.0%
Medicare case mix index	1.51	2.13
Gross price per discharge	$11,688	$20,204
Net price per discharge	$5,850	$12,757
Cost per discharge	$5,703	$12,144

Provident Healthcare

National Health Company

Provident Healthcare

National Health Company

Ratio of Total Equity Market Value to Number of Discharges

Table 4: U.S. Treasury Yield Curve
Maturity	Interest Rate
6 months	3.0
1 year	3.5
5 years	3.9
10 years	4.5
20 years	5.0
30 years	5.1
Market Risk Premium
Historical risk premium	7.0%
Average current risk premium as forecasted by three investment banking firms	6.0%
Market Beta s, Capitalization, and Tax Rate s of Two Publicly Traded Hospital Companies
Company	Beta	Debt/Asset Ratio	Tax Rate
		Provident Healthcare	1.1	50%	40%
		National Health Company	1.2	65%	43%
Ratio of Stock Price to EB1TDA per share
6.1
7.9
	Ratio of Total Equity Market Value to Number of Discharges
$7000
$6000
Large hospital average	5.0%
Note: The data in this table reflect assumptions to ease the case analysis, as opposed to actual data.

Page 1 of 11

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