Has Dr. Jacob Terner extended himself too far?
Last month, Brotman Medical Center filed for Chapter 11 bankruptcy reorganization, reporting an estimated $50 million in debts, along with an $11 million net loss in 2006.
That’s not the outcome Terner could have wanted when his publicly held physician practice management company, Prospect Medical Holdings Inc., led a group of investors to buy the struggling Culver City hospital.
But Terner, a savvy businessman who 20 years ago built up a regional HMO before selling it off, appears to have insulated his Culver City company from the worst of it.
Prospect didn’t directly acquire Brotman, but rather took a leading interest in a separate corporate owner. That move allowed it to quickly write off the value of its $1 million, 38 percent stake, though the Prospect still receives management fees from the hospital.
However, with at least 10 Los Angeles County hospitals closing their doors in the past five years, the trouble may not be over for Prospect.
Even as Brotman was quietly struggling, Prospect recently piled up debt to acquire four more local hospitals. In August, Prospect was able to finance with junk-rated bonds the acquisition of Alta Healthcare System Inc. in a cash-and-stock deal valued at $103 million. Alta owns small community hospitals in Hollywood, Norwalk and elsewhere.
Prospect’s business model is to be a so-called “vertically integrated” health care services organization through its management of physician groups and hospitals. In theory, that should allow Prospect to negotiate richer reimbursement contracts with the tight-fisted payers that are its bread and butter. That includes government agencies, such as Medicare and Medi-Cal, and private health maintenance organizations.
However, that plan isn’t winning universal praise.
“(Terner) has a tough payer mix,” said Steve Valentine, president of The Camden Group, a national health care consultancy based in Torrance. “Medi-Cal is a lousy payer, and HMO enrollment is declining. You really can only grow there by taking market share away from other providers.”
Terner was out of the county last week and could not be reached for comment. Other executives at Prospect and Brotman did not return calls for this story.
Tenet Troubles
Back in 2005 when Prospect bought Brotman, where Terner launched and ran the pathology department for many years, it was among a number of area hospitals snapped up by doctors who thought they could do better after Dallas-based Tenet Healthcare Corp. decided largely to exit the Southern California market a few years ago. But the hospital, like several others, has proved difficult to turn around.
Last week, Centinela Freeman HealthSystem, a doctor-led investor group with three former Tenet hospitals, agreed to sell its flagship Centinela campus in Inglewood to Victorville-based Prime Healthcare Services Inc.
In addition to Centinela, at least two other former Tenet hospitals are rumored to be in severe enough financial straits to be considering a sale or cuts in services.
“With Brotman, you have yet another hospital that Tenet sucked dry and then sold to underfinanced community benefactors who wanted to keep them open. It’s not a surprise that many of the owners are now struggling,” said Carol Meyer, director of governmental affairs for the Los Angeles County Department of Health Services.
Moreover, in the current environment, the debt that Prospect has taken on to fund recent acquisitions, which includes a $48 million cash-and-stock deal in May for Ontario-based physician’s association Promed Health Care, has troubled debt rating agencies closely monitoring the company’s finances.
The company reported $41.4 million in long-term debt at the end of its third quarter ended June 30, up 459 percent from the same period a year ago.
Stephen Zaharuk, a senior credit officer with Moody’s Investor Service, gave Prospect’s first lien credit facility that helped finance the Alta purchase a grade at least five levels below investment grade debt. An accompanying second lien facility was rated at an even lower Caa2.
“They are doing OK, but they want to take on debt to expand into something that’s not familiar to them. In a market like California, that’s pretty tough,” Zaharuk said. “We have to look at what’s the possibility for them to get into trouble.”
Prospect did report a 20 percent rise in net income to $4.9 million in fiscal 2006. But it has had an uneven 2007, with a second-quarter loss and small profits in the first and third quarters. The company has not yet reported its fourth quarter.
However, some investors do believe Prospect is on the right track. While Prospect’s stock tends to trade thinly and was selling for less than $5 a share on the American Stock Exchange last week, Scott Nussbaum at Broadlawn Capital LLC believes investors will show more interest once the recent acquisitions are consolidated.
“Despite appearances, there is a lot out there that gives us confidence in investing on the weakness in their stock price,” said Nussbaum, whose New York hedge fund began accumulating Prospect shares in 2006. Prospect’s net income was 60 cents per diluted share in 2006 and he expects it to hit $1 within the next three years.
Nussbaum believes Prospect’s ability even to finance the Alta deal in August, during the height of the credit market meltdown, was an impressive feat. In addition, the earlier Promed deal, which also was debt financed, turned Prospect into the sixth-largest independent physician association manager in the state with 250,000 covered lives.
“They’re using that debt to make themselves a larger company and that will only help them in the future in negotiating contracts,” Nussbaum said.
Nussbaum also likes how both acquisitions were structured, with the sellers showing their faith in Prospect not only by taking a significant equity stake but also signing multiyear employment agreements.
Alta’s former owners, Sam Lee and David Topper, are now Prospect’s two largest shareholders, each with 8.3 percent of outstanding shares. Promed’s former owner, Dr. Jeereddi Prasad, is the fifth-largest shareholder at 3.48 percent.
The 73-year-old Terner, now the company’s third-largest shareholder, exercised options in October to acquire more than $1 million of his company’s shares, bringing his stake to 6.47 percent.
