By Pete Gallo
May’s market mayhem didn’t stop Andreas Halvorsen’s Viking Global Investors long/short fund from hitting a resounding home run on one of its recent portfolio picks, Psychiatric Solutions.
Filings with the Securities and Exchange Commission show that Viking at the start of the second quarter owned 1.6 million shares of the Franklin, Tenn., mental health services firm. The position was a new addition to the Viking portfolio and made the hedge fund one of the company’s largest shareholders with roughly a 3% stake in the firm, filings show.
It was a daring bet. Psychiatric Solutions shares had been struggling since the final quarter of 2009, when they fell from a high of $27 to a low of $18. The stock later languished, hitting about $21 per share in March, when Viking entered the fray. But since then the stock has skyrocketed, hitting $32.44 per share as of June 4.
The stock’s gain of $11.44 over that period would have boosted the value of Viking’s stake to $51.9 million, for a gain of $18.3 million since March, assuming no shares were sold or added.
But it’s better than that. The gains seen for Viking Global and other shareholders are permanently locked in, thanks to a May 17 announcement that rival United HealthCare Services in King of Prussia, Pa., will be buying Psychiatric Solutions for $2 billion in cash, at a share price of $33.75.
Luck? Unlikely. Viking deserves serious credit for spotting this quirky investment opportunity that seems to be anything but textbook value investing. United HealthCare Services’ acquisition of Psychiatric Solutions is seemingly an investor’s nightmare, with United pledging to pay $2 billion for a company laden with $1 billion in debt, filings show.
That’s tough medicine. In fact, the day after the deal was announced, Fitch lowered United HealthCare Services to noninvestment grade BB and issued a negative outlook for company debt on May 18.
So if Psychiatric Solutions’ bulky debt made such a buyout deal unlikely, what tipped off Viking and other investors that an acquisition was in the works? What we do know is that heavy options volume grabbed the attention of some investors, who became aware in late February that Psychiatric Solutions’ top executives were putting in place fat exit packages, which suggested some sort of deal was being planned. Those rumors drew headlines, and a number of investors, including Viking, piled into the stock around that time.
But as it turns out, Halvorsen’s hedge fund is on both sides of the merger deal. Viking Global owns roughly 4.8 million shares of United HealthCare Services, a 5.3% stake in the company, based on filings for the quarter that ended March 31. That stake was recently and dramatically increased, as filings show only 192,000 shares of United were held in both the previous quarterly filings. United HealthCare Services owns and operates some 25 medical hospitals and 102 behavioral centers in 32 states and in Puerto Rico and the Virgin Islands. So its acquisition of Psychiatric Solutions’ 94 inpatient mental health facilities will widen its geographical coverage and consolidate its market position, providing economies of scale.
Yes, that’s boilerplate merger talk. But what is the Street’s verdict? Following the May 17 announcement, shares of United HealthCare Services have traded in a surprisingly narrow range after an 8% price jump on the day after the merger announcement. And the stock is still up respectably since the start of the quarter, rising from $35 on March 31 to $43 as of June 4, an all-time high. The value of Viking’s stake rose to $206 million, for a gain of $38.4 million.
United HealthCare Services’ deal to pay $2 billion cash for a mental health company with $1 billion in debt, and the stock’s subsequent rise, clearly shows that investors are exceptionally eager to buy and hold just about anything that has strong growth potential in this tough market, even if that growth is in psychiatric services. Notable from a stock-picking perspective, the deal between Psychiatric Solutions and United HealthCare Services also proved a rare double-barreled merger win for Viking. In otherwise uncertain markets, you sometimes have to make your own luck. Just ask the exiting execs at Psychiatric Solutions who will be leaving with $30 million. Even so, investors are so hungry for growth they are bought shares on the same day that Fitch put a downgrade warning on the debt.
