Magellan files for Chapter 11 to halve debt


Magellan Health Services Inc. made official yesterday what the Columbia mental health company had been talking about for months, voluntarily filing for Chapter 11 bankruptcy reorganization.

Steven J. Shulman, the relentlessly upbeat chief executive officer who came on board in December, termed the filing "a very exciting and positive development for the company." Magellan brings in enough money to cover operating expenses, he said, but "we just can't service our debt."

An acquisition push in the mid-'90s bought Magellan three of the four largest companies in its field, but also ran up more than $1 billion in debt.

Magellan's reorganization plan must be approved by the U.S. Bankruptcy Court in Manhattan. It calls for holders of half the company's debt to trade it for nearly all the stock in the restructured company, effectively reducing the debt from $1 billion to $500 million.

"They spent so much money putting that company together that it was an enormous challenge trying to grow the company, pay the debt and deliver good service," said James W. Wrich, CEO of J. Wrich & Associates Inc., a Madison, Wis., consulting firm that evaluates mental health services.

"We've extinguished half a billion dollars in debt," Shulman said. "It's gone, not refinanced."

Shulman said the company would operate normally. Magellan said it had received permission from the bankruptcy court to pay claims for mental-health service incurred both before and after the bankruptcy filing - during the reorganization.

The company has 778 employees in Columbia and about 5,200 nationally. Shulman said there has no layoff plans connected to the Chapter 11 filing.

Magellan's plan has the unanimous backing of a committee of note-holders, which has been meeting with the company since the fall.

"This is going to put the company on a path not only to perform, but to excel," said Saul E. Burian, a director of Houlihan Lokey Howard & Zukin, the investment banking firm that has been advising the note-holders' committee.

In the filing, Magellan listed $998.9 million in assets and $1.47 billion in liabilities, according to Bloomberg News.

The plan also includes a two-year extension of its contract with Aetna Inc., Magellan's largest customer.

Magellan owes Aetna $60 million, which was due last month, from its purchase of Aetna's mental health unit. Aetna agreed to accept $15 million when Magellan emerges from bankruptcy, with Magellan promising to pay the balance within two years.

Stock falls to 4.4 cents

Magellan's current stock - which lost 1.6 cents a share yesterday to close at 4.4 cents - would become worthless, although holders of common shares would be given stock worth one-half of 1 percent in the reorganized company.

A bankruptcy filing such as Magellan's, in which there were preliminary talks with creditors and a reorganization plan accompanying the initial filing - known as a "pre-pack" - is becoming "a lot more common," said Charles Shafer, a University of Baltimore law professor who teaches a bankruptcy course.

"If all goes as planned, it's less messy and less expensive and goes faster," Shafer said.

Although creditors who did not participate in the committee may object, Burian said, "In the preponderance of situations, bondholders will follow the lead of the ad hoc committee."

Magellan is paid by HMOs, employers and governments to cover mental health services. In turn, it contracts with hospitals and therapists to form a network, and pays claims. It covers mental health or employee assistance benefits for 68 million Americans, making it triple the size of its nearest competitors.

Originally an operator of mental hospitals, Magellan became by far the largest company in the behavioral managed-care field in the late 1990s by buying three of the largest operators in the field.

"It took three companies that were doing fairly well, and now, five or six years later, it's in serious financial trouble because of all the debt they incurred," Wrich said.

With less than $2 billion in annual revenue, Wrich said, "they had to pay out $260 million a year in debt and interest."

Magellan's Shulman compared it to being "house poor," similar to a family that paid so much for a beautiful residence that it couldn't afford furniture.

The restructuring brings Magellan's debt down to supportable levels, said Thomas H. Shinkle, a high-yield debt analyst at Imperial Capital LLC in Beverly Hills, Calif., who follows Magellan.

As a general rule, he said, a company can handle debt equivalent to three times its annual cash flow. He projects Magellan's cash flow at $140 to $180 million a year, in line with the $500 million in debt it would have after the restructuring.

Now, he said, Magellan needs to "raise prices to cover expenses," at a time when claims have been increasing, as well as invest in new computer systems.

'Very difficult'

That's easier said than done, Wrich said. "In that business, it's very difficult to raise your prices, because there are a lot of three-year, fixed-price contracts."

Also, he said, Magellan is "competing against people with less debt," who might be able to capture Magellan clients with lower prices.

Two major Magellan customers in Maryland said they expected Magellan to continue providing service. CareFirst BlueCross BlueShield, which uses Magellan for 2 million of its members, issued a statement saying:

"We endorse Magellan's optimistic outlook that this financial restructuring will result in an even stronger and more viable partner."

And Karen Black, a spokeswoman for the state Department of Health and Mental Hygiene, said the agency had been assured that Magellan's services to the state Medicaid program "will go on as usual."

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