Hospital M&A: looking peaky

One company offers to buy another; the target's board accepts; the target's stock price falls. That last step is very odd - demand and price should move together. But this week Health Management Associates, the US hospital operator, accepted a $13.78 per share offer from its rival Community Health Systems. HMA's shares, which had been trading at $15, fell a tenth after the news and have stayed there. Investors deserve an explanation

The reasoning from Community, and by proxy HMA, goes as follows. The stock had already risen sharply on speculation about a deal. And the deal was disclosed on the same day as HMA cut its 2013 earnings targets (one of several similar cuts in recent years) and disclosed the receipt of subpoenas from US health regulators (which follow others from the Securities and Exchange Commission about billing and revenue). Community knew about all the bad news when it made its offer. Finally, the offer, including the assumption of HMA's debt, totals $7.6bn, or about 8.5 times HMA's expected 2013 earnings before interest, taxes, depreciation and amortisation. On that metric, the price is a bit higher than the one Tenet paid for Vanguard in June.

None of this is especially convincing. Investors have not been given much information about the lowered profit targets - there was no call with analysts - and very likely know less about them, and perhaps about the subpoenas, than the buyers do. So the earnings multiple may be a poor guide to valuation. The real earnings power of the company, when not in crisis, is unknown. Where there is smoke, there is probably a fire sale.

There is, however, good reason for HMA investors not to kick up too much of a fuss over 10 per cent or 20 per cent. The equity market in general, and hospital stocks in particular, look peaky. The cyclically-adjusted price/earnings ratio for the US market is over 24, which by the standards of the past 150 years is entering bubble territory. Over the past year, the seven big publicly traded hospital operators are up an average of 90 per cent; HMA is up even more. It is a great time to sell but may not be for long.

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