Between 1997 and 2006, HCA (HCA) made 10 acquisitions and established itself as a leading U.S. hospital operator. The company achieved leadership through consolidation of hospitals which it improved through scale and expertise, leading to higher levels of profitability.

Yet despite this, the market largely ignored what it was doing.

As a result, it went private in 2006 through a leveraged buyout and waited for a change. And it got one four years later when former President Barack Obama signed the ACA into law.

The ACA required everyone in the U.S. to have health insurance. Hospitals didn’t have to worry as much about bad debt, and so their profits skyrocketed. As a result, HCA’s current hospitals became more profitable and it had more acquisition targets to choose from.

HCA’s management took the company public again at $30 per share in 2011. Within four years, shares had tripled. They sit around $418 per share today.

Because the health care system is so complex, it often takes time for the market to come around to these stocks. Investors have to grasp just how valuable different health care providers are and where they fit in the ecosystem.

Since regulatory winds are shifting yet again, investors should look to companies that are working towards efficiency as they tend to benefit from this.

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Between 1997 and 2006, HCA (HCA) made 10 acquisitions and established itself as a leading U.S. hospital operator.

The company achieved industry leadership through its ability to consolidate the then-highly fragmented hospital industry. Back then, HCA would buy a hospital and improve operation using its scale and expertise, leading to higher levels of profitability.

Yet despite the company’s efforts, the market shrugged it off. And even as it upped its dividends by nearly two-thirds, its stock only went up by 24% while the S&P 500 doubled in the same time frame.

As a result, then-CEO Jack Bovender turned to Jim Forbes, former head of Merrill Lynch’s health care investment banking operation.

Selling the business seemed out of the question. Bovender assumed HCA was too big for any private-equity (“PE”) buyer. At an almost $18 billion market cap, with $11 billion in debt on the books, it was the behemoth of the hospital space.

Forbes, instead of offering to lend money to HCA so it could issue debt and buy back more shares, proposed a leverage buyout (“LBO”).

With an LBO, a PE firm takes out a large amount of debt to acquire a company instead of using cash to complete the acquisition.

PE firms fix up a broken business by cutting costs and focusing on its most important parts. Eventually, they sell it again for a huge profit.

The mid-2000s were a new “boom time” for PE. Univision had just been bought for $12 billion. GMAC, General Motors’ finance arm, netted a $14 billion deal. And Kinder Morgan had been taken private at a $22 billion valuation.

PE funds were flush with money and looking to spend it. Within less than three months, HCA went private at a $33 billion valuation.

Now, the plan was never to keep HCA private forever. It was all about buying time. The company dropped off the public markets while investors didn’t understand it.

Then, it waited for a change. And it got one four years later, when President Barack Obama signed the Affordable Care Act (“ACA”) into law.

Before the ACA, many hospitals were drowning in bad debt from patients who weren’t insured and couldn’t pay their bills. That was part of why investors were suspicious of HCA in the 1990s and 2000s.

The ACA required everyone in the U.S. to have health insurance. Hospitals didn’t have to worry as much about bad debt, and so their profits skyrocketed.

As a result, HCA’s current hospitals became more profitable and it had more acquisition targets to choose from.

HCA’s management took the company public again at $30 per share in 2011. Within four years, shares had tripled. They sit around $418 per share today. That’s more than a 13 times return.

Because the health care system is so complex, it often takes time for the market to come around to these stocks. Investors have to grasp just how valuable different health care providers are and where they fit in the ecosystem.

Once HCA went private, it took an act of Congress for investors to come back around. And now, the regulatory winds are changing once again.

Government programs and other health care payers are looking to lower costs. But patients still need quality care.

Investors should look to companies that are working towards the system’s push for efficiency.

Outpatient surgical centers and urgent care operators are winning patients away from expensive hospital stays. Telehealth platforms are reducing the cost of visits and relieving appointment wait times. There are health technology companies that are working to streamline billing and claims to make the whole industry more efficient.

These are the businesses that thrive when every dollar in health care is being scrutinized. They lower costs while keeping quality intact, making them natural beneficiaries today.

Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research