How Leonard Green took control of Prospect in 2010

analysisPMH's 2010 merger proxy recounts that from October 2009 management met potential sources of capital, including Leonard Green, and that on April 13, 2010 Leonard Green, on behalf of Green Equity Investors V, submitted a nonbinding proposal to buy all PMH shares for $7.50 in cash, conditional on Samuel Lee, David Topper, Mike Heather and Dr. Jeereddi Prasad rolling over a significant part of their equity. The merger closed on December 15, 2010 at $8.50 a share: Ivy Merger Sub Corp. merged into PMH, PMH became an indirect wholly owned subsidiary of Ivy Holdings Inc., and its common stock ceased trading on the NASDAQ Global Market. Immediately before the merger Lee (Chairman and Chief Executive Officer), Heather (Chief Financial Officer), Topper (President of the Alta Hospitals System subsidiary) and Prasad (a director and President of the ProMed Health Services subsidiary) contributed a total of 6,227,824 PMH shares to Ivy Holdings for 529,365 Ivy Holdings shares. ^{1 2}

analysisThe proxy estimated PMH's own merger expenses at $6,135,000, including a $2,600,000 financial adviser fee and $3,100,000 of legal fees, and PMH's compensation committee approved a $1,235,000 bonus for Lee payable only on completion of the merger. The FTC granted early termination of the Hart-Scott-Rodino waiting period on September 14, 2010. Lee's December 2010 Schedule 13D amendment, filed as a group with David R. Topper, Alexa Topper, Heather and Prasad, reported that after the merger the group no longer owned any PMH common stock directly or beneficially and that PMH was deregistering its securities. PMH filed Forms 15-12B and 15-15D to end its SEC registration and reporting; its EDGAR record ends with filings made on July 26, 2011, when PMH also reported the results of a consent solicitation from holders of its senior secured notes to amend their indenture, including its reporting covenants. ^{1 2 3 4 5}

analysisIvy Holdings Inc. was formed and, before the merger, solely owned by Green Equity Investors V, L.P. and Green Equity Investors Side V, L.P., Delaware limited partnerships affiliated with Leonard Green & Partners, L.P., which the proxy described as a private equity firm with about $9 billion of equity commitments under management; the general partner of each fund is GEI Capital V, LLC. The merger subsidiary, formed on July 21, 2010, belonged to Ivy Intermediate Holding Inc., itself wholly owned by Ivy Holdings, and after the merger Ivy Intermediate owned all 100 outstanding shares of PMH, which had no public trading market. The proxy describes Ivy Holdings as a Delaware corporation controlled by the Leonard Green funds, with its business address care of Leonard Green at 11111 Santa Monica Boulevard, Los Angeles, John Baumer as its President and Leonard Green vice president Alyse Wagner as its Vice President, Secretary and Treasurer. ^{1 2}

analysisPMH's fiscal-2010 annual report lists Ivy Holdings' owners after the merger as Green Equity Investors V (46.0%), Green Equity Investors Side V (13.8%), Ivy LGP Co-Invest LLC (1.5%), Lee (20.2%), the David & Alexa Topper Family Trust (14.9%), Heather (1.6%), Prasad (1.2%) and other PMH employees (0.8%). Its March 2011 quarterly report summarises this as 62% indirect ownership by the Leonard Green funds and 38% by the rollover and additional employee investors, and records a capital contribution of about $844,000 from the funds. Before the merger, the proxy's beneficial ownership table of November 8, 2010 listed Lee with 30.3% of PMH, the Topper family trust with 22.9%, the Terner Family Trust of Jacob Y. Terner and spouse with 8.8%, Nelson Obus with 6.6%, Joshua Landes with 6.3%, Heather with 3.4% and Prasad with 1.8%. The 54.5% that the table also attributes to Ivy Holdings, GEI Capital V, Leonard Green and related entities arises from voting agreements with the rollover investors; these are not additional shares. ^{2 3 1}

analysisIvy Holdings' board adopted a stock option plan on December 15, 2010 and on February 22, 2011 granted options over 86,476 Ivy Holdings shares to fifteen PMH employees. At the closing Ivy Holdings, Ivy Intermediate Holding and PMH signed a tax sharing agreement allowing PMH to make payments to its two parents for taxes they owe as parents of the consolidated group. ³

analysisThe proxy estimated that about $150,976,370 was needed to complete the merger, including about $127,984,876 for stockholders, $21,705,123 for option holders and $1,210,371 for warrant holders. Under an equity commitment letter the Leonard Green funds committed to buy $161,000,000 of equity in Ivy Holdings: $118,818,000 from Green Equity Investors V (73.8%) and $42,182,000 from Side V (26.2%). Besides common stock, the funds bought Ivy Holdings' 13.5% Senior Redeemable Exchangeable Cumulative Preferred Stock, with an initial liquidation value of about $69,180,000, for about the same price; it carries a cumulative annual dividend of 13.5% of liquidation value, ranks ahead of the common stock for dividends and is redeemable at a premium starting at 107% in 2011 and falling to 100% in 2015. The funds also agreed to backstop the change-of-control repurchase of PMH's senior secured notes; holders tendered $8,200,000 of notes, which PMH repurchased effective January 19, 2011. ^{1 2 3}

analysisOn the closing date PMH and U.S. Bank National Association, as trustee, signed a First Supplemental Indenture permitting PMH to make certain “Restricted Payments” immediately after the merger, and PMH and Royal Bank of Canada signed a consent amending covenants of PMH's credit agreement. PMH's fiscal-2010 annual report states that it had not previously paid cash dividends on its common stock and that its new credit agreements allowed dividends of up to 50% of consolidated net income when no default existed. Its unaudited balance sheet at March 31, 2011 showed total assets of $388.1 million, liabilities of $294.8 million, long-term debt of $150.3 million plus $22.8 million current portion and stockholder's equity of $96.4 million, with six-month revenue of $294.5 million and a net loss attributable to PMH of $3.8 million. ^{2 3}

analysisLater accounts describe the size of the 2010 transaction differently: the U.S. Senate Budget Committee's chair and ranking member refer to a $205 million acquisition, the Rhode Island Attorney General to Leonard Green buying a majority of the public shares for about $150 million, a consultant's report for the Rhode Island Department of Health to Leonard Green's initial investment in Ivy Holdings of about $151 million, and a nonprofit research report to a $363 million leveraged buyout that assumed $158 million of debt. The figures measure different things (total transaction value, the equity paid for public shares and the funds' own investment) and are reported by the bodies cited rather than taken from the 2010 merger documents. ^{4 5 6}

analysisAfter the merger, affiliates of Leonard Green had the right to designate three of PMH's five directors: John Baumer, a Leonard Green partner since 1999 who led the due diligence for the Prospect acquisition; Michael Solomon, a principal since 2000; and Alyse Wagner, a vice president since 2003 who took part in the due diligence. All three became PMH directors on December 15, 2010. The management stockholders designated the other two directors, Lee and Prasad. ¹

analysisOn December 10, 2010 PMH formed a wholly owned subsidiary, Prospect Green Management, LLC, to be used solely to pay Leonard Green for advisory services. Under a management services agreement dated December 15, 2010 the subsidiary agreed to pay Leonard Green & Partners an annual fee of $1,000,000 regardless of the services provided, a one-time $4,000,000 structuring fee for the merger, fees for major transactions as agreed and up to $50,000 a year of expenses, for a ten-year term renewing annually; by March 2011 it had paid the $4,000,000 fee and $441,000 of merger expenses. Lee signed the agreement as chief executive of Prospect Green Management and Baumer for Leonard Green through its general partner, LGP Management, Inc.; Ivy Holdings and Ivy Intermediate Holding unconditionally guaranteed the subsidiary's obligations. ^{1 2 3}

analysisShareholder class actions challenging the buyout were filed in the Delaware Court of Chancery, including Bruce Lessey v. Prospect Medical Holdings, Inc. (filed August 25, 2010) and Thomas McCormack v. Samuel Lee (September 1, 2010), against PMH, the rollover investors, the special committee members, the Leonard Green funds, Ivy Holdings, the merger subsidiary and Leonard Green. They were consolidated on September 28, 2010 as In re Prospect Medical Holdings, Inc. Shareholders Litigation, C.A. No. 5760-VCN, alleging breach of fiduciary duty over the price and process, and six shareholders filed a second action on December 30, 2010. These are allegations in shareholder complaints; PMH's March 2011 quarterly report states that the defendants believed the actions were without merit, and no later outcome was found in the retained records. ^{1 2}