Monday, July 24, 2006

HCA to explore private parts...

If you are a stock holder, its unequivocally a great outcome.

If you are a bond holder, its your worst nightmare.

If you are a disinterested capitalist, you know this is the efficient market at its best.

Its called an LBO. And they are growing more popular every day.

The latest company to get caught up in the LBO craze is HCA, the largest hospital operator in the U.S. You can read all about the details here (subscription required). I note that the premium is only 7% higher than Friday's close, so the Frist family must think the company will truly be worth more private or this wouldn't be much of a deal for them.

I haven't seen any quotes on HCA bonds today, but generally when a Ba-rated company increases their debt load 2 1/2 times (as is rumored to be the case here), the bond rating suffers greatly. Basically the group providing the equity for an LBO is saying, "This company is too conservative with its balance sheet. Return on equity is the name of the game, and it could be much higher if the majority of the firm's assets were funded by debt. Bond holders may whine about it, but management doesn't work for bond holders. We'll just tell them to shove it."

The situation is grim for bond holders. Private equity firms raised $134 billion last year, and considering that LBO's involve large amounts of leverage and usually significant contributed capital from other principals, private equity firm's buying power is substantially greater. For example, according to the Wall Street Journal, Merrill Lynch, Bank of America, Citigroup and J.P. Morgan are helping to arrange $15 billion in new debt to fund the transaction, which is valued around $21 billion. So the private equity group is putting up about $6 billion and leveraging their money 3 1/2 times.

Meanwhile, according to Private Equity Intelligence (quoted in a Bloomberg News story), private equity firms may raise $300 billion this year. At 3-4 times leverage, that gives private equity firms more than $1 trillion in buying power.

The bottom line is this. If you own a diversified portfolio of stocks, odds are good one or more of them will become an LBO target, and you will enjoy wonderful profits. If you own a diversified portfolio of corporate bonds, one or more of them will become an LBO target, and you will suffer.

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