Medical Device Daily Associate

SAN FRANCISCO — What does a company do that for some reason has fallen out of favor with the public markets?

One, it can elect to tough it out and maintain its public status or, two, it can find a private buyer and attempt to reinvent itself outside the public eye.

A panel at last week’s JP Morgan Healthcare Conference, titled “The Going Private Phenomena in Healthcare,” investigated what some have seen as a growing shift towards companies taking the road more private.

Panel moderator John Coyle, a managing director at JP Morgan, said that especially in 2006 “we’ve seen a significant level of private equity activity across just about every industry with the most noticeable trait being the [large] size of the transactions.”

As examples of these transactions over the past year, he cited hospital operator HCA’s (Nashville, Tennessee) $33 billion acquisition, the acquisition of media giant Clear Channel (San Antonio) for $27 billion; casino operator Harrah’s (Las Vegas) for $26 billion, and the $11 billion buyout of orthopedics company Biomet (Warsaw, Indiana). “These mark some of the largest private equity transactions ever,” said Coyle.

He noted that 30 of those transactions in 2006 in the U.S. were public-to-private “which dwarfs the number of public-to-privates that have occurred over the prior years and, again, they typically comprise the larger transactions.”

Of those transactions, he noted about half as unsolicited — “and the vast majority of them, with very rare exceptions, have been successful. They have been met with acceptance by boards and shareholders and, on average, have commanded a 20% to 30% premium,” to there share price.

He also noted that the market, from a multiples perspective, is now every bit as favorable to a private transaction as it is for going public.

Coyle asked Tim Sullivan, who heads the healthcare practice at Madison Dearborn Partners, what public investors are missing that groups like his clearly see in the current environment.

“We’re comfortable in leveraging the balance sheet of the companies [that we acquire].” Sullivan said. Secondly he noted that when it takes control of a company, the purchasing company is “bellying up to the bar and putting equity in the deal as well. The dialogue between ourselves and management is a very direct one.”

If a company must reengineer, a private company has the advantage, he said.

“To the extent that things don’t go as well as we planned, we’re going to be there to change and fix any problems. The public markets tend to have a more diffuse ownership, and I don’t think they can look to one person to enact those particular changes at the board level that we can do in a private realm.”

Sullivan said that the premium prices paid for these companies are justified by the level of accountability that they can extract from management in a private situation, “particularly for companies that are typically out of favor. Everything today seems to be expensive, but the fact is we’re looking at businesses in many cases that the public, for whatever reason, has fallen out of favor with.”

Jonathan Coslet, head of the healthcare practice at Texas Pacific Group, said that while there is accountability for private CEOs, their public counterparts have a much tougher time “and it should be difficult. The public companies have an imperative to perform and it’s incumbent upon the managing teams to deliver.”

Many of the problems that these public officers have stem from the short-term shareholder expectations, particularly when hedge funds are thrown into the mix. So when these people come to manage private investments their mindset has to change.

“When [officers] come into a private environment like ours, we have no ability to create value in a short time; we’re always going to be long-term investors and therefore, if it takes some time to make the investments in a long-term setting, we can do that, and quite frankly we have to do that.”

Coslet also noted that private companies can avoid the inefficiencies that public companies deal with, particularly the hassle with Federal Trade Comission and accounting issues, allowing focusing on strategy and delivering results.

Mike Michelson of Kohlberg Kravis Roberts & Co (KKR), agreed with other panelists in stressing the need for private equity firms to look at any acquisition as a long-term project.

“We’re not constrained by current thinking and we’re not constrained by current earnings. In fact, we’re not really driven by earnings. Were driven much more by cashflow so I think we have a different lens that we can look through. We can work with management to set out a long-term strategic plan and execute along those lines.”

In the healthcare sector, Michelson, a senior partner at KKR, said the private way of doing things can prove to be particularly advantageous, since there is less emphasis on long-term development goals vs. the short-term pressures of the public realm.

Coslet characterized the healthcare sector as one of the “trickiest to invest in,” particularly if attempting to account for the ever shifting sands of Medicare reimbursement. At the end of the day, a company must determine its relative bargaining power within a local market dynamic, he said.

Eventually, many of the going-private companies will return to the public sector, but Sullivan said this is not contradictory for the private equity firms, who are ultimately looking to gain cash liquidity from their investments.

Michelson said that when contemplating a private investment, one must already be planning its best exit strategy. For HCA, for instance, there is strong likelihood that company will eventually be back in the public sector, he predicted. And he noted “multiple avenues,” from taking a company public, to selling to a strategic buyer, to recapitalizations.

Michelson quipped that it doesn’t take “a genius to pay the most money for a company,” and that what happens after the buy is the most critical element for success. “Given the long holding periods [an average of seven years} that we have, it’s very difficult to generate the kind of returns that we’re looking for through simple financial engineering. You really have to work with the company to improve that company over time.”

Sullivan said something in the range of “20% or better” defines a good investment. The trick, he said, is to be a diversified. A healthcare investment “is a very different kind of investment . . . from others that we are very active in.”