A Loser
MedPartners
63.9% Decline
(NYSE: MDM)
www.medpartners.com
12/30/97 Price: 22 3/16
6/30/98 Price: 8

The Company's Biz. Like many tragedies, the fall of MedPartners began with good intentions. When Richard Scrushy and Larry House teamed up to found the company in 1993, the concept seemed admirable and straightforward enough -- develop a business that will allow doctors to spend more time with their patients and less time doing back-office administrative duties.

With private practice doctors groups starting to feel the heat from managed healthcare providers and for-profit hospital firms, MedPartners offered a much sought-after alternative. Doctors were more than happy to let a management company fill out the endless insurance forms and chase down uncollected back payments from patients. Uniting with other doctors groups under a single umbrella organization also offered the old "strength in numbers" advantage, placing the docs in a better bargaining position vis-a-vis the HMOs upon which they relied for an increasing part of their business.

MedPartners' physician practice management business quickly grew from nine doctors and roughly $4 million in patient revenues in 1993 into the industry's leader by the end of fiscal 1997, with more than 11,000 affiliated physicians generating $3 billion in net revenues.

The Story. The company's tremendous top-line growth was fueled primarily by acquisitions. By the end of 1997, the Birmingham, Alabama-based firm had managed to acquire a total of 287 practices and had expanded into the pharmaceutical services and contract medical services areas, which accounted for just over half of MedPartners' fiscal 1997 net revenues. A high-flying share price enabled the firm to keep up the feverish acquisition pace through the issuance of more and more shares.

However, companies that live by the sword often die by the sword. For MedPartners, it was partly an acquisition that threw the company off its growth track and sent its share price careening downward. But this time, the firm was the target and not the buyer. The acquirer was rival PhyCor Inc. (Nasdaq: PHYC), which offered to by the much larger MedPartners in October 1997 for $8 billion in stock and assumed debt.

At first, everything seemed fine. One Wall Street analyst said the combined firm, with annual revenues of $8.4 billion, would be "the tiger of the industry." The bomb hit just over a week into 1998, though. First, PhyCor gave MedPartners' shareholders a collective shove by calling off the deal, citing "significant operational and strategic differences." Simultaneously, MedPartners took out its own shareholders' legs by saying it misjudged the extent of medical claims in its Western operations, an error that would result in a forecasted fiscal Q4 loss from continuing operations of about $0.25 per share. Analysts had been hoping for a profit of $0.32 per share.

The company's shares were nearly cut in half on Jan. 8, down to a level from which they have barely budged over the past few months. Things got really ugly two months later when the firm reported a loss of $1.01 per share for the quarter -- four times worse than its earlier guidance -- which effectively destroyed any remaining credibility it had with the markets.

How Could You Have Seen This Coming? To be fair, many analysts were skeptical of the PhyCor merger from the start. The two companies operated in different markets and ran their businesses in different ways. PhyCor was conservative and deliberate when it came to acquisitions; it relied on smaller markets, where doctors are typically paid based on services rendered.

MedPartners, on the other hand, was aggressive on the merger front and focused on large urban markets, where most physicians are paid on a flat-fee per patient schedule often dictated by managed care organizations. Those flat-fees, referred to as "capitated" member rates in HMO lingo, were also worrisome. With the demand for healthcare services rising -- producing higher costs across the board and more referrals to specialists -- the fixed-price revenue model left MedPartners without much pricing power and largely at the mercy of the big league HMOs. The company's large exposure to the California market, with its "open access" policy, which gives patients easier access to specialists, only exacerbated the problem.

The Future. CEO Larry House resigned shortly after the Jan. 8 blowup, and was replaced in March by former Magellan Health Services (NYSE: MGL) chairman and CEO Mac Crawford. James Dickerson, former CFO at Aetna's (NYSE: AET) Aetna/U.S. Healthcare unit, came on board two months later as the firm's new financial guru. Crawford is credited with transforming Magellan from a small-time psychiatric care provider into the nation's largest managed behavioral healthcare firm, while Dickerson is known as a savvy manager with tons of healthcare experience. Investors are hoping the two can work a transformation at MedPartners and get the company back to its 25% historical annual growth rate.

MedPartners has continued to make acquisitions over the past few months, even though its currency of choice -- its stock -- remains greatly depressed. Prior to Jan. 8, the company was able to buy out physician practices with a stock valued at around 30 times trailing earnings. After two consecutive quarterly losses, its P/E ratio is now negative. On the bright side, its pharmaceutical and contract medical services businesses are good revenue generators. Going forward, the biggest challenges for MedPartners will be controlling costs and becoming more adaptable to the fluctuating price of healthcare in this country. The company's business concept still makes sense -- management just needs to find a way to wring consistent and increasing profits out of it.

-Brian Graney (TMF Panic)

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