By Bobby Guy
 
We've discussed the importance of early intervention for struggling healthcare companies in the current market.  Who are the major players in the healthcare field when it comes to financial advisory and turnaround management services?  Managers should have this list, because hiring a good financial advisor is often more important to improving performance.  Indeed, while lawyers are often good referral sources for financial advisory firms, hiring an experienced financial advisor is often a step that should precede hiring restructuring counsel. 
 
Without being fully inclusive (no list could be), here are the names of some of the major firms that specialize in providing financial advice to struggling companies in the healthcare industry -- most are not exclusive to distress, but work for healthy companies in performance consulting and similar functions as well.  These are set out in alphabetical order (the tyranny of the alphabet avoids any show of preference), and this is not a recommendation, but a list of firms that have demonstrated specialized expertise in the healthcare field.  If we've missed one of the majors, we'd look forward to hearing about it (we're sure we will), and will include them in a follow-up blog. 
 
• Alvarez & Marsal
• Bridge Advisors 
• Capstone Advisors 
• Centre Health Partners  
• Cohen & Steers Financial Advisors 
• Conway, Del Genio, Gries & Co. 
• Focus Management  
• FTI/Cambio  
• Healthcare Management Partners  
• Healthcare MCR 
• Huron/Wellspring  
• Houlihan Lokey Howard & Zukin  
• Navigant Consulting  
  
For questions about or contact information regarding any of these firms, e-mail bobby.guy@wallerlaw.com.

By Bobby Guy
 
If there are only six strategies for a struggling healthcare company to overcome financial difficulties, what is most important implication?  Simply this: the survival of a struggling company is directly related to its ability to recognize and respond to the struggle early.  The later the intervention, the less likely a struggling healthcare company is to survive.  Management teams need to be on top of company finances while there is still money (and therefore resources) to fix the problem.   I often liken financial difficulties to the evacuation of the US embassy during the fall of Saigon: every hour that goes by results in the evaporation of hundreds of opportunities, and lacking intervention, the result is a chaotic stampede as the last helicopter takes off with people holding onto the struts. 
 
Unfortunately, if history is any guide, many managers will not quickly recognize or embrace the need for change. 
 
The implications?  In the next 1-2 years in the healthcare industry, a number of marginal performers will likely change hands as they deny their financial difficulties, and as a result, are sold or liquidated when their other options have evaporated.   This will create a number of opportunities for savvy buyers in the market to purchase assets; asset prices will correct involuntarily for struggling companies as a result of distress sales. (For an outline of purchase opportunities for the distressed asset buyer, click here.)  For the struggling company wishing to avoid this outcome, early intervention, and usually the hiring of a well-trained financial advisor or turnaround manager, is key.   More on financial professionals in a future issue. 

By James B. Bristol

The 2008 proxy season has been completed for most companies, although fiscal year issuers are still conducting annual meetings. If you are a publicly traded company, your proxy was no doubt reviewed by Institutional Shareholder Services (ISS), which is owned by Risk Metrics. ISS reviews more than 38,000 proxies each year, and its influence with proxy voting is significant. Some institutional shareholders engage ISS to actually vote their proxies, based solely on ISS’s recommendations. Glass, Lewis & Company is another proxy and shareholder advisory service that reviews most proxies. Glass Lewis, however, seems to have only a fraction of the institutional business of ISS and does not seem to match ISS in influence.
Many companies have hired ISS to review their stock plan proposals under the ISSue Compass model to ensure that ISS will issue a favorable recommendation when it reviews the proxy. To mitigate the possibility of conflicts of interest, ISS has a “Chinese Wall” that separates the corporate services group who reviews your proxy under ISSue Compass and the proxy review group. We have seen, unfortunately, recent cases where the corporate services group gives a green light under ISSue Compass, but the proxy review team (on the other side of the wall) recommends no. These are some possible responses to a no recommendation from ISS:

1. Do nothing and hope that your proposal passes anyway. This strategy has worked for companies with no significant institutional shareholders, or with a large block of stock represented on the board. Some institutionals may not place significant weight on ISS recommendations, though this group seems smaller than it was. A good proxy solicitor can help you assess the leanings of your institutional shareholders. For many companies, doing nothing might not be the best option.
2. Call your larger institutionals and explain the reasons for your proposal. Shareholders usually appreciate being called and may go along with conditions. In a stock incentive plan proposal, for example, you may be asked to formally restrict option repricing.
3. Contact ISS to change the proposal in a way that will allow it to pass under their metrics. We’ve seen several examples where a stock incentive plan failed due to the company’s average “burn rate” (i.e., the rate that stock awards are granted). ISS generally will change to a “yes” if the company formally limits the burn rate to its industry average and files an 8-K or 14A proxy amendment.
4. Use your proxy solicitor service to solicit votes from non-institutional shareholders. Many of these shares may go unvoted. We have it on good authority that this can work.

We have found that these options, particularly 2 and 3, work best if your proxy solicitor and legal counsel work together to identify what will be persuasive and then communicate that to your shareholders and/or ISS. In one recent case where ISS had initially made an adverse recommendation on a stock plan proposal, we were able to help ISS find an error in the assumptions used in the burn rate analysis. They were happy to correct their analysis and promptly issued a reversal notice. Maybe ISS isn’t so bad after all.

By Joseph Woodruff and Wynne James

Here's the last of three red flags that ought to warn an investor to either stay out of the water to begin with, or make an immediate exit.

3.  Generic account statements

Publicly traded investment securities are purchased and sold through “exchanges” such as the New York Stock Exchange, the NASDAQ, the Chicago Board of Trade and other similar markets both in the United States and abroad.  A stock broker or investment fund manager is not physically going to take an investor’s cash, go to the floor of the NYSE, purchase shares of a company and hold them for the investor’s account. 

Instead, a legitimate broker will place orders for stock trades through a registered broker/dealer that is a member of the National Association of Securities Dealers (NASD).  This registered broker/dealer will close the actual stock purchase and sale transactions either directly, or through intermediary entities that are “members” of the various stock exchanges.  A legitimate broker will furnish his or her customers with periodic account statements that disclose all of the activity in their accounts.  These statements will usually be on a form generated by the registered broker/dealer and will contain certain disclosures required by securities laws and regulations.

An investor should immediately question the bona fides of a document purporting to be an account statement of transactions in publicly traded securities that does not disclose the registered broker/dealer through which the trades were processed. The simplest explanation for such a document is that it is a complete fabrication intended to conceal from the investor the fact that his “investment manager” has stolen the money instead of investing it.

By Bobby Guy
 
What are the likely results of the liquidity crunch in the healthcare market?  The water is building behind the dam for a significant number of asset sales at reduced prices, as the market takes its toll on marginally-performing healthcare companies.  During the period of excess liquidity and rising asset prices, marginal companies are able to prop up their performance by getting significant infusions of cash at the lower levels of their capital structure, such as second lien, mezzanine financing, preferred equity and high yield debt.   And take infusions of cash they did.  That money is no longer available, however, and the result is that many companies must stand on their own "current" performance -- not the hope of a future fix.  By borrowing in the last cycle, the same companies also increased the debt service that they must now pay back, further tightening the strain. 
 
It is important to realize that for a struggling company, there are six exit strategies, and only six:

1. Resurrecting the company by fixing its performance (increasing revenues/decreasing expenses)
2. Refinancing the company to stretch its obligations (not a very viable option in the current credit market)
3. Re-equitizing the company (with an equity infusion - also difficult to come by in the current financial market)
4. Re-amortizing the debt (through voluntary debt reductions taken by creditors, or through a bankruptcy proceeding)
5. Selling the company as a going concern (unfortunately, at lower prices due to the current market), and
6. Liquidating the company (never a good option).  

For an in-depth discussion of the strategies, see my recent article in The Journal of Corporate Renewal, a journal written for "turnaround" professionals that help companies overcome their struggles.
 
In the next blog, we'll cover the implications of these strategies for healthcare companies in the difficult credit markets.  

By Joseph Woodruff and Wynne James

Here's the second of three red flags that ought to warn an investor to either stay out of the water to begin with, or make an immediate exit. 

2.  The money manager wants a loan

Frequently, the perpetrators of a securities fraud manage to avoid detection because the investors receive periodic distributions of money.  These distributions are often made possible because, in classic Ponzi scheme style, the perpetrator is using the cash contributed by new investors to make payments to old investors.  Because there is no genuine value in the investment, whenever an investor wants to liquidate his or her position, the perpetrator needs to raise cash quickly.

We have seen instances where the perpetrator, often in an effort to raise funds quickly, turns to unwary investors and asks them for personal loans.  It is highly irregular and inappropriate for an investment manager to borrow money from his clients, and such a request is a warning of fundamental problems with the manager and the investment account.

By Bobby Guy

It has been almost exactly a year since Waller Lansden opened this blog, with an article entitled "Liquidity and Healthcare."  That opening blog discussed the effects of excess liquidity in the healthcare market.  Now, a year later and in the midst of a widely-recognized liquidity crunch, the economics of the healthcare market have shifted significantly.
 
Interest rates have continually dropped, but as they have, healthcare lenders have widened the spreads at which they loan, and have reinforced their lending standards.  The result is that borrowing is much more expensive now than a year ago.  The pendulum swings, and it has swung from one pole of "irrational exuberance" to the other of "fearful caution."  The mergers and acquisitions market is one area that has been dramatically affected: many healthcare equityholders still want 2006/first-half 2007 prices for healthcare businesses, while healthcare purchasers want the lower price multiples that reflect the new market.  And without them they cannot buy, because their lenders are only willing to lend at lower multiples.  For example, lending multiples that a year ago sat at 5-7 times cashflow at the highest ranges, have now dropped to 3 or 3.5 times, or even slightly less.  What will be the results?  Some predictions in the next blog. 

By Joseph Woodruff and Wynne James

Just like the flags staked out on the beach warning swimmers to avoid the undertow, there are signs that should warn investors of the possibility that their securities accounts are at risk of being pulled under by fraudulent managers or promoters.

In the last 12 months, we have seen the exposure of at least four massive frauds that have swallowed up tens of millions of investor dollars. 

What could investors have looked for that might have been warning signs that their portfolios were exposed to risks other than general market conditions?  Below is the first of three red flags that ought to warn an investor to either stay out of the water to begin with, or make an immediate exit.  We’ll provide the rest in the days ahead.

1.  A promised return too good to be true

Fraudulent securities deals frequently promise the investor a return that “beats the market” or carries with it “no way to lose your money.”   A now-defrocked insurance broker named B. Don James was recently sentenced to federal prison for crimes arising out of a fraudulent investment scheme in which he made both promises.  He was selling promissory notes that guaranteed a 10 percent return.  The principal amount contributed by the investor was supposedly going to be pooled with money from other investors and used to finance insurance premiums on policies purchased by James’ insurance customers.  James promised the investors that if a customer defaulted on the premium finance repayment, then the insurance policy would be cancelled and the unearned premium refunded, thereby making the investor whole.

His victims testified that James told them, “The only way you can lose you money is if I steal it.”  At least that statement was proven to be true.

By James Bristol

Two proxy seasons have now come and gone since the SEC introduced new compensation disclosure rules, including the requirement of a compensation discussion and analysis (CD&A). Our bulletin summarizes our general observation of this process. Notwithstanding this regulatory effort to curb abuses, executive compensation continues to grab news headlines. For example, a recent article in USA Today shouts “CEO Pay Climbs Despite Companies’ Struggles.” This article ranks the top ten paid CEOs in 2007, beginning at $34.1 million for Occidental Petroleum all the way up to $83.1 for Merrill Lynch. These numbers include cash and the value of non-cash items (such as stock options) disclosed in annual reports and proxies.

The news stories all focus on companies in the Fortune 100 or 250. What is reported there has very little or nothing to do with the world of compensation in smaller companies. Typical pay for CEOs of small-cap and mid-cap companies is a small fraction of those pay levels. Indeed, some small-cap companies would consider the CEO compensation at large-cap firm to be a worthy annual revenue goal.

The compensation buzz is similar to the effect of Sarbanes-Oxley on smaller companies. The rules are pretty much one-size-fits-all, whether the company has $100 million or $150 billion in revenue. For the smaller company, the cost and complexity of compliance is out of proportion – and the worst part of it. Many executive perks that are common in larger companies, such as supplemental retirement plans and corporate jets, are hard to find in a smaller company. CEOs in most companies are paid modestly in comparison to their colleagues in the Fortune 500. Yet the ferocity of the disclosure rules falls on all equally.

Many companies have previously enjoyed a fairly informal compensation process. This is to be expected when the CEO is a founder and the board members are from the venture capital firms that initially invested in the enterprise. The new disclosure rules have forced development of formal compensation processes, as well as discovery and articulation of past compensation decisions. Our perspective is that mid-cap and smaller companies were generally not doing the sorts of things that were targeted in the SEC’s compensation disclosure rules. This is borne out by the results. For smaller companies, very little in the way of “hidden” compensation has come to light under CD&A and new compensation disclosures.

Note: this experience could be relevant to those who are urging adoption of shareholder approval of executive pay, or “say on pay.” While the shareholders of Merrill Lynch may have views about paying their CEO $83 million, it seems unlikely that the shareholders of a mid-cap company are going to focus as much on the $3 million paid to its CEO.