Several large pension funds that invested with a private equity fund in the late 1980s now expect a hefty return from National Medical Enterprises' $3.3 billion cash and stock purchase of American Medical Holdings if the hospital megamerger is completed in the coming weeks.
The $51 billion General Motors Corp. pension fund, the $16.5 billion Los Angeles County Employees' Retirement Association, the $60.7 billion New York State and Local Retirement Systems, and the $14.5 billion Boeing Co. pension fund are among investors expected to benefit from the sale.
The purchase is expected to be final sometime this quarter. As a single company, NME/AMI Healthtrust would rival the size of Columbia/HCA Healthcare Corp., a Louisville, Ky., company that bills itself as the nation's largest health care provider.
The pension funds all are investors in AMI through GKH Partners, Farmington, Conn., a private equity investment fund. GKH investors also include the Pritzker family. GKH owns 32% of AMI.
Three investors, GKH, a First Boston Corp. partnership and the pension fund of General Motors Corp., which made a second, separate investment in AMI, own 60% of the company.
As a GKH partner, the Los Angeles County fund has had a total annualized investment return of 14.7% from the GKH partnership from April 1988 through June 30, 1994. The return will be significantly boosted by the sale of AMI, said David J. Locke, a senior investment analyst with the fund.
Mr. Locke said he couldn't estimate what the fund's total return would be from the AMI deal because he doesn't know the timing of the cash flows or the price of AMI shares when the purchase is completed.
But the Los Angeles fund will show an effective net profit of $109 million to $130 million on its original $52.5 million investment in AMI, which was placed in late 1989, Mr. Locke said.
Based on the size of their original investments, the other pension funds should have similar returns, proportional to the amount they invested.
The pension funds will benefit from a consolidation drive that has swept the hospital industry. However, GKH, which had a direct hand in the company's management, did some extensive cost cutting to get the hospital chain in shape. In 1990, AMI sold its 65% stake in an 18-hospital British subsidiary and sold seven other hospitals in four foreign countries. The company also sold three acute care hospitals in California and Maryland as well as four of its five psychiatric facilities nationwide.
The Los Angeles County fund and the GM pension fund are believed to be the two largest investors in GKH.
As shareholders, the pension funds will have the right to convert each share of AMI common for $19 in cash and .42 shares of NME common stock.
Mr. Locke estimated the value of NME shares at $18 to $22, but NME shares were selling at $14 Jan. 18. The total value of the investment to each pension fund will depend on the value of NME common at the effective time of the merger, Mr. Locke said.
The announced AMI purchase by NME is described by financial observers as one of the 10 most significant deals in the United States last year.
When GKH first approached the Los Angeles fund back in 1988, public pension fund investments in private equity were uncommon, despite the emergence of buy-out specialists Kohlberg Kravis & Roberts. However, the fund trustees agreed to make an investment partly on the reputation of GKH partners and partly on the knowledge that the GM pension fund was a major investor.
Mr. Locke said the Los Angeles fund probably will continue to make private equity investments, in part because of its favorable experience so far.
"It does help reinforce the belief that there are exceptional returns that can be made. It appears more public funds will put part of their allocation into private equity," he said.
In November 1989, IMA Holdings, a private investment group of GKH Partners L.P., and First Boston Investments, a subsidiary of First Boston Corp., New York, acquired AMI in a $3.09 billion transaction that included $1.67 billion in cash and the assumption of $1.42 billion of debt.
Besides the pension funds, investors in the GKH part of the buy-out included the Pritzker family of Chicago and several insurance companies., including Equitable Life Assurance Society of the United States, American Homes Assurance, Wells Fargo Bank and First Chicago Investment Advisors.
Shortly after the original buy-out, the GM fund invested an additional $75 million in equity to reduce the amount of junk bonds that had to be sold to finance the buy-out.
GM's financial assistance was especially important because of the downturn in the junk bond market. The high-yield securities were needed to refinance the bridge loan that was made to complete the acquisition of AMI.
As a result of GM's equity purchase, First Boston's investment was reduced to $60 million from $100 million.
The additional cash from GM, with GM's earlier agreement to purchase a portion of the $125 million in subordinated debt securities, reduced the amount of junk bonds that had to be sold to $475 million from $600 million.
Without the GM pension fund's additional cash, GKH would have had to make a second capital call of $35 million on its limited partners to raise its equity investment in the deal to $185 million from $150 million to satisfy outside lenders.
GKH Partners originally was organized to make long-term equity and equity-related debt investments. The investment partnership began in 1988 with more than $545 million in equity capital available.
Of the original capital, $150 million came from the Los Angeles County fund; $50 million each from the Pritzker family, the GM pension fund and New York State & Local system; $35 million from the Boeing fund; $25 million each from Equitable, American Home Assurance, Wells Fargo Bank, First Chicago Investment Advisors; and $10 million total from general partners Mel Klein and Harry Gray and special limited partner Dan Lufkin. Another $105 million came from various unidentified investors.
Mr. Gray was former chairman and chief executive officer of United Technologies Corp.
GKH has made other investments and is planning to set up a second fund with some of the original general partners. It is asking the pension funds to invest in the second partnership.