Magellan gets handle on its crippling debt

Catharsis: A bankruptcy judge approves Magellan's reorganization plan to free itself of $600 million in debt.

October 09, 2003|By M. William Salganik | M. William Salganik,SUN STAFF

For Magellan Health Services, getting from Point A to Point B has been a rocky road.

Point A was acquisitions. Already one of the biggest mental health insurers in the country, the Columbia company bought two of its three largest competitors in a three-month span in 1997 and 1998. Magellan was triple the size of the second-largest company in the field, providing mental health coverage for more than 70 million people, or one in three insured Americans.

"They significantly overpaid for their acquisitions" and then failed to realize projected cost savings from combining companies, said Joseph Marinucci, a Standard & Poor's analyst. Profits dropped as more people sought mental health counseling after the Sept. 11 terrorist attacks.

That led Magellan to Point B - bankruptcy. Profitable on an operating basis, but unable to meet the payments on more than $1 billion in debt amassed during its buying spree, Magellan filed voluntarily in March for reorganization.

Magellan's plan to complete its reorganization and emerge from bankruptcy won the approval yesterday of U.S. Bankruptcy Judge Prudence Carter Beatty in Manhattan. The restructuring wiped out about $600 million in debt by giving the lenders stock in the new company, which employs about 700 people in Columbia and more than 4,700 nationally.

For Magellan, where is Point C?

Steven J. Shulman, who was appointed in December as the turn-around chief executive officer, hopes Point C is consistency - an end to a cycle in which the company would sometimes report solid quarters, but periodically missed projections by significant amounts.

When Shulman arrived at Magellan, he knew bankruptcy was likely. By getting in and out of reorganization quickly and by attracting new investment, he said, "things went significantly better than I hoped or planned." Having gained the court's approval, Magellan now expects formal emergence from bankruptcy in the next few months.

With its debt reduced, "we are supremely confident of our ability to achieve new goals," Shulman said yesterday.

Cost savings will be a significant feature of Magellan's recovery, he said. Marinucci, the analyst, projects $25 million in cost cutting in 2004 and $50 million in annual savings after that.

Shulman said the acquisition strategy wasn't a bad one, but admits the cost of the companies it bought was high.

Magellan paid $560 million for Merit Behavioral Care Corp. and $422 million for Human Affairs International, the mental health unit of Aetna Inc. Now, all of Magellan is valued in its reorganization plan at $285 million (although that's up from $138 million before the bankruptcy filing).

"Who didn't overpay for stocks in the late '90s?" Shulman asks.

However, Magellan didn't get the savings its huge size was expected to generate. Shulman expects to gain efficiency now by getting all the company's claims on a single software system and by cutting back significantly on its current 35 or so call centers.

While Shulman said he hopes to hold overall employment steady, some jobs may be lost and others moved. Already, attrition has pared Magellan's work force by 75 positions in Maryland and 400 nationally, compared with its pre-bankruptcy size.

"If you try to save everybody," Shulman said, "everybody sinks together."

No decisions have been made about the future size of headquarters staffing or which of the regional call centers will be shut, the chief executive said. Also, if the company meets future targets, he's budgeting money to reward employees - from executives to claims processors - who have stuck with Magellan through a difficult year.

By exchanging stock for half its debt, Magellan gets to cut its debt service payments. Although "the balance sheet is still viewed as kind of weak," Marinucci says, the refinancing will nearly halve the amount Magellan needs to pay to lenders.

Before the reorganization, debt payments ate up about $90 million a year - half of the company's cash flow.

Magellan also attracted new money from a Toronto investment company, Onex Corp., which will provide up to $150 million. Onex, in turn, will own most of the shares that the lenders don't, and will control a majority of the voting stock.

The losers are the pre-bankruptcy stockholders, who will receive only a thin slice of stock in the reorganized Magellan.

Now, analysts said, Magellan should have enough money to invest in saving money, such as updated computer systems and office consolidations. Capital spending, typically about $35 million a year, will rise to about $50 million a year to pay for needed efficiencies, before dropping down again, said Melissa Rose, Magellan's vice president for investor relations.

Shulman also said that while Magellan isn't counting on growth in its conservative projections, he believes that growth will come.

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