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MUTUAL SERIES FUNDS'
MICHAEL PRICE ET AL.
(continued from preceding
page)
OID: I see what you mean. As of June 30th, it looks like Health Systems had nearly $500 million of cash. Divided by its 50-odd million shares outstanding, that's roughly $10 per share.
Garea: That sounds about right - although, again, that's before the acquisition of Foundation Health.
OID: So deducting that $10 from its current price of $24 per share, you're paying less than $14 per share for an HMO with nearly $70 per share of revenues. That seems dirt cheap.
Garea: And it's even reasonably well managed.
OID: Again, it would certainly seem so. Despite the heavy goodwill amortization you mentioned earlier, Value Line shows them earning a return on equity in the mid to high 30s in 1993, 1994 and 1995.
Garea: Also, it's very well positioned. It's in California and lots of other states. And it's going to expand. So it'll ultimately be one of the larger HMOs out there and just generally continue to do well.
OID: Could the unfavorable response to the Foundation deal indicate that Health Systems is overpaying and/or di-worse-ifying?
Garea: I don't think so. Because they're paying 1.3 shares of Health Systems, they're, in effect, paying $32. And Foundation's selling at a little over $30.
OID: And I see that Foundation has about $900 million in cash - which divided by its 60 million shares outstanding comes to about $15 per share. So Health Systems is effectively paying $16-17 per share for slightly over $70 per share in revenues.
Garea: That's right.
OID: So it's only mildly dilutive in terms of revenues. And you say it should be additive to earnings.
Garea: Exactly. It was the cheapest HMO before the acquisition by a lot. And now it's even cheaper. Meanwhile, almost every other HMO's moved up sharply. And Health Systems has barely moved at all. So now it's extraordinarily cheap.
OID: On the other hand, Health Systems' earnings estimates have been declining for at least six months.
Garea: That's right. But that's probably been true for every HMO.
OID: How would you rate management?
Garea: I think they're OK. I don't think they're the best. These companies all have strengths and weaknesses. But I don't think most industry observers would put them in the top two or three in the industry.
OID: Where would they put them? And where would you put them?
Garea: In the next tier from the top.
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