Magellan races to recast future as debt looms

HMO: Columbia health services company sees long-term growth, but debt may consume its future.

Health services

May 07, 2000|By M. William Salganik | By M. William Salganik,SUN STAFF

Columbia-based Magellan Health Services will announce quarterly earnings this week, but it's already warned that profit will be about 10 percent below expectations.

Change is never easy - and Magellan has changed a lot.

It used to be a Georgia company. Last year, it moved its headquarters to Maryland, employing about 1,000 employees in Columbia, and 12,000 nationally.

Five years ago, it was a company that operated mental hospitals. Then, it bought controlling interest in Maryland-based Green Spring Health Services, a company that got it into the business of being, in effect, an HMO for mental health, collecting premiums and contracting with therapists and hospitals for care.

Now, Magellan is out of the hospital business altogether. Its mental health HMO, or "behavioral managed care," has grown dramatically; in a three-month period in late 1997 and early 1998, it bought two of Green Spring's biggest competitors, tripling in size almost overnight. It is now the largest in the business by far, covering mental health benefits for 69 million Americans and pulling in revenue of $1.9 billion last year.

In the process of transforming itself, it's built up a billion-dollar debt load and posted lackluster earnings. Its stock, which traded for more than $30 a share in 1997, just before it began its major acquisitions, closed Friday at $3.625.

"It's been a pretty ugly process," especially getting out of the hospital business, said Monica Oss, president of Open Minds, a company that consults and publishes newsletters on the behavioral health industry.

"In the long term, their prospects are good, but in the short term I don't see any catalyst" to push share prices back up, said Eleanor Kerns, a health analyst with Credit Suisse First Boston, who has a "hold" recommendation on the stock.

Magellan's problems stem from assumptions in 1997 that haven't been borne out.

The debt grew in large measure from a sharp decline in the performance - and the value - of the hospital unit, Charter Behavioral Health Systems. Dr. Henry T. Harbin, the psychiatrist who is Magellan's chief executive officer said that as Magellan decided to buy two of Green Spring's largest rivals, "The major calculation we made back in '97 is that we assumed Charter as an operating company could be sold for several hundred million dollars."

After selling a half interest in Charter in 1997 for $400 million, Magellan negotiated a deal the next year sell the other half for $310 million - but the buyer backed out when the hospitals' performance continued to decline.

Finally, last year, Magellan gave away its share, ending $6 million a year in losses, but getting nothing to pay down its debt.

Magellan did get a cash infusion in December, when venture capitalists Texas Pacific Group kicked in $59 million in exchange for preferred stock. That diluted per-share earnings somewhat, but, Kerns said, "it was a very big vote of confidence for Magellan, and in general investors thought it was positive."

Magellan could reduce its debt further if it sells its National Mentor unit, which operates group homes and therapeutical foster placements. Kerns said Mentor could be worth $200 million, to $300 million, but if Magellan can't get that price, it wouldn't be worth it because the loss of Mento would depress earnings.

Harbin said the prospects and timing of the sale are uncertain, but, "Our major plan at this point is to sell Mentor at the right price, and to continue to grow out of the debt. As we continue to grow, the amount of debt in relation to our earnings gets better."

Magellan's growth prospects depend on both its already-huge behavioral managed care unit and a newer (and, at this point, unprofitable) specialty health unit.

Specialty health, sometimes called "disease management" is, Oss said, "an industry that's looking for a model."

Magellan, which bought a specialty health business in 1997, has some ideas, but Harbin admits, "We don't know if there will be a customer for our vision."

The basic concept is that patients with chronic diseases, such as asthma, diabetes or cardiovascular problems, consume a large chunk of health spending, and that good management - regular checkups, proper medication, sometimes diet and other lifestyle changes - can keep the patient healthier and costs down.

Kerns said that while the idea of managing costs by managing diseases is attractive as medical inflation climbs, the field is very fragmented.

There are publicly traded and private players. Some specialize in a specific disease, such as cancer. Some focus on inpatient care. Some are units of pharmacy benefits management companies.

"Over time, we assume we'll see consolidation of the players," Harbin said. "The pure management companies may be the winner, but there are a lot of us out there pitching."

Magellan offers several products, including a 24-hour nurse advice line and a group that monitors patients at home, including sending out information packets on their condition.

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