Palms-based hospital and physician group Prospect Medical Holdings Inc. is facing a hostile takeover attempt from one of the biggest hospital chains in the country, Prime Healthcare Services.

Ontario-based Prime and its founder and chief executive, Prem Reddy, made an offer in late November to acquire Prospect Medical for $50 million cash and the assumption of all debt.

Prime’s bid came several months after Prospect’s management agreed to a reported $12 million buyout of its largest investor, Sawtelle-based private equity firm Leonard Green & Partners.

Prospect Medical’s management has rejected Prime Healthcare’s offer, saying in a statement that the management buyout was agreed to months ago by an “overwhelming” majority of shareholders and was therefore legally binding.

But a Prime Healthcare spokeswoman last week told the Business Journal the company’s general counsel had determined Prospect Medical’s management buyout agreement was not made public and that shareholders were not presented with any alternatives.

In Prime Healthcare’s buyout offer letter, Reddy said he would be willing to make his case directly to Prospect Medical and Leonard Green, and that if his offer were approved, Prime would be prepared to close the deal within 90 days.

Rapid growth

Prospect Medical was founded in 1996 in Orange County and has grown through acquisitions into a chain of 20 hospitals in six states, 165 specialty care outpatient clinics, and a network of more than 11,000 primary care physicians and specialists affiliated with its hospitals.

The company would not disclose revenue, but revenue figures have appeared elsewhere, and Prime Healthcare’s buyout offer listed Prospect’s revenue as $3.1 billion.

In 2011, Leonard Green & Partners purchased a majority stake in Prospect Medical for $363 million in cash and debt, taking the company private. Prospect Medical management retained a 38% stake, including a 20% stake for board Chairman and Chief Executive Sam Lee.

Prime Healthcare, which was founded by Reddy, a physician, in 2001, has specialized in buying hospitals facing financial distress and improving their financial position.

It is now the fifth largest hospital operator in the country, with 45 hospitals in 14 states and $4.7 billion in revenue last year.

Through the years, Reddy and Prime Healthcare have been the focus of controversy. The company has frequently tangled with the powerful SEIU-United Healthcare Workers West, an Oakland-based union representing roughly 150,000 healthcare workers throughout California.

Last year, Prime Healthcare agreed to pay $65 million in penalties to settle a lawsuit brought by the Department of Justice alleging that it filed false claims and made improper hospitalizations at several of its hospitals to pad Medicare billings. Reddy was also personally assessed a $3.25 million penalty.

Bidding war

The buyout saga began last year when Leonard Green & Partners decided to sell its stake in Prospect Medical Holdings. Then, earlier this year, Leonard Green agreed to sell its stake to a team of Prospect Medical management led by Lee.

Financial terms of the agreement were not made public, but reports surfaced that Prospect Medical management had agreed to pay roughly $12 million to Leonard Green; that figure was also contained in Prime Healthcare’s buyout offer letter.

“We understand that Leonard Green & Partners is considering selling its stake in Prospect Medical Holdings … with a valuation of approximately $12 million,” Reddy states in his Nov. 15 letter to John Baumer, senior partner with Leonard Green and a Prospect Medical Holdings board member.

Prospect did not dispute the $12 million figure in its response to the Business Journal.

Reddy’s letter laid out the case for why the Prime offer is superior. “We believe that Prospect has a substantially higher value and are willing to pay and hereby offer to pay $50 million for the company. … We believe that this significantly higher price offer will significantly improve your return on investment — both to your investors and to (Leonard Green & Partners).”

The buyout offer came in conjunction with a letter on behalf of minority shareholders and stock option holders of Prospect Medical Holdings. That letter, signed by more than 30 current and former employees, said the management buyout deal agreed to earlier this year would strip many employees of stock options accrued during their years at Prospect Medical.

More market strength

Reddy did not say in his letter why Prime Healthcare wants to buy Prospect Medical. But a cover letter from Prime Healthcare’s attorney in the matter, Gary Gertler, managing partner of the Century City office of Chicago law firm McDermott Will & Emery, did offer some explanation, focusing on the three states where both Prospect Medical and Prime Healthcare have hospitals.

“Prime’s hospitals in California, Pennsylvania and Rhode Island present significant opportunities for synergies and market strength to improve performance,” Gertler said in his letter.

Prime Healthcare spokeswoman Elizabeth Nikels elaborated in an email response, giving examples of where the merger of the two hospital chains would yield benefits.

“Prime is addressing the ongoing need for behavioral health services across the nation by adding behavioral health beds throughout our facilities to help serve even more vulnerable community members,” Nikels stated.

But Prospect Medical sees things differently. “We believe Prime’s attempt to insert itself into this transaction is intended solely to disrupt Prospect’s operations in markets where our hospitals and other facilities compete with Prime’s. We remain focused on continuing to provide quality, compassionate healthcare in the communities we serve across the country.”