A hedge fund associated with Forth Worth, Texas-based Q Investments LP has asked the board of Quorum Health Corp. to conduct an independent investigation into “potentially unlawful behavior” in connection with the initial guidance Community Health Systems (CHS) used to market its spinoff of Quorum to potential investors, and to promptly “take appropriate legal action” against CHS before the health system enters into any potential sales transactions. 

In April CHS spun off 38 hospitals, along with Quorum Health Resources, a hospital management business CHS acquired in 2007, into Quorum Health Corp., a separate, publicly traded company. The transaction raised $1.2 billion for CHS.

When Quorum released its second-quarter earnings in August, it reduced its 2016 guidance by more than 30 percent, from a midpoint of $270 million of EBITDA to a midpoint of $187.5 million. Quorum’s stock price dropped 50 percent the next day, resulting in what the hedge fund claims was “at least $560 million of value destruction.”

Q Investments stated in a letter it sent to Quorum Health board members that it believes CHS, “desperate to raise cash,” knowingly provided inflated EBITDA guidance to potential Quorum investors and concealed costs “within what they knew was a disintegrating business.” The letter also called into question whether Quorum’s management team was “complicit in the possible fraud.”

A spokesman for CHS said in a statement to The Wall Street Journal that the company “categorically rejects” the allegations, and that it “made all necessary disclosures throughout the process.”

Our Take: What a mess. CHS decides to take an assortment of underperforming hospitals in small markets—cities or counties with populations of 50,000 or less—throw in their hospital consulting company and create a new business. The idea, at the time, was to allow CHS to focus in its major markets.

Which is good for CHS, but where’s the value creation? Where is the inherent value in having a consulting company, which prior to all of this had a good reputation, saddled with the infrastructure of 38-odd small community hospitals across the United States?

We have no idea whether anyone inflated the numbers. The truth is that this was a bad idea from the start. Investors should have known better.

If it sounds like we are being too harsh (apologies to our CHS readers), compare this transaction to some recent strategic mergers that are bound for success. RWJBarnabas Health. Providence St. Joseph’s Health. Hackensack Meridian Health. Each deal offers strategic expansion in their core geographic markets, scale opportunities, complementary service offerings, and a plan to be profitable in a value-based world. All were eyes-forward to the health care of the future.

Last month CHS said it was “exploring options,” including a sale. We have now reported several times in recent weeks about additional one-off sales from the hospital operator in order to reduce the weight of the $17 billion in debt it’s drowning in.

CHS hasn’t been right since it acquired 71 hospitals from HMA in 2014. That deal was hatched in a different era, when size was the only thing that mattered.

No one knows where CHS will be, or what they will be, by the end of next year. One thing is certain: they’re not too big to fail.

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