Fraud Alleged In 2016 Community Health Systems(CYH) Spinoff Of Quorum Health(QHC)

In April 2016, Community Health Systems(CYH) spun off Quorum Health Corp(QHC).  Quorum borrowed $1.2 billion and paid it as a dividend to Community Health prior to the spinoff, a large sum considering Quorum’s current market cap of $245 million, down precipitously from its debut, but more than double its November lows.

Reuters reports that hedge fund Q Investments has alleged fraud to Quorum Health’s Board, and that the Board has launched an investigation. Q is a ~$1.5b Texas based fund that has shown in its past that it isn’t afraid of a fight. In its October letter to Quorum’s Board, Q Investments shared its serious concern.

“We believe Community Health was desperate to raise cash, and they saw an easy path to do so by stuffing new investors in Quorum with inflated guidance and concealing costs within what they knew was a disintegrating business,”

Quorum has taken the allegations seriously

Quorum has retained attorney Robert Varian from Orrick Herrington & Sutcliffe LLP as independent counsel to be part of its board’s probe into how its separation from Community Health Systems Inc was handled in April 2016, according to the letter and the person familiar with the matter.

For its part, Community Health Systems denies the allegations

Community Health Systems spokeswoman Tomi Galin said: “We categorically reject the allegations by Q Investments that Community Health Systems committed fraud or any other wrongdoing in connection with the Quorum spin-off. Community Health Systems conducted itself appropriately and made all necessary disclosures throughout the process.”

It was well known at the time of the transaction that Quorum Health was being burdened with an unbearable debt load. This has often been a sign of a spinoff to avoid. Q’s allegation is that Community Health knew that the fundamentals of Quorum’s business were deteriorating, specifically that costs were increasing, and that it failed to disclose this very material information.  Whether this allegation will be sufficient to disgorge some or all of the dividend from Community Health or whether there is some other recovery for Quorum shareholders remains to be seen. This is a strong reminder of the danger of spinoffs that seem to exist only to shore up the balance sheet of the former parent.

Disclosure: The author holds no shares in any stock mentioned