Tenet tries novel, if risky, “dart frog defense”

December 10, 2010

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Dart frogs are attractive little fellows, but the brightly-colored amphibians can kill predators that try to eat them. Tenet Healthcare has pulled out many arguments in rejecting a $3.3 billion hostile stock and cash bid from rival hospital chain Community Health Systems. The most unusual imitates the dart frog: our past performance has been so toxic that you’ll be sorry if you buy us.

Wall Street loves the idea of combining the two companies. Costs can be cut. Moreover, recent healthcare reforms are good for hospital chains as fewer uninsured patients should mean fewer bad debts. Yet valuations are still reasonable — the offer for Tenet contains a 40 percent premium, but is still below the average takeout multiple of EBITDA for hospital chains, according to analysts. Tenet shares on Friday afternoon traded 10 percent above the offer, and Community Health’s were also up sharply.

So Tenet’s contention that the bid is opportunistic carries the ring of truth. Other rebuttals, such as its claims that Community Health’s shares are undesirable due to aggressive accounting or that the combination would be overleveraged, are more debatable.

But the dart frog defense is the most novel. Tenet operates under U.S. government oversight as the result of a 2006 settlement over alleged Medicare fraud. The argument is that if Community Health swallows Tenet, the combined company would be subject to the same oversight — and that the purchaser doesn’t have the personnel or experience to comply. That could result in fines or, worse, expulsion from federal programs.

Tenet also points out that its tainted history has an upside. It has accumulated losses that shield $2 billion of future income from taxes.

Such a defense is risky, however. For one thing, it may not work. Dart frogs raised in captivity aren’t poisonous due to their diet. Tenet has been under government supervision for several years, and Community Health may think the risk has dwindled in potency. The bigger danger is that this defense tactic scares away other potential suitors or gives Community Health an excuse for not raising its bid. That would leave a sour taste in the mouths of Tenet shareholders.

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