Reports buzz of LBO deal near for Health Net.

Is Health Net, the Woodland Hills-based health maintenance organization that covers about 875,000 Southern Californians, on the auction block again?

Rumors and trade reports abounded last week that Pueblo, Colo.-based Qual-Med, an ambitious HMO merger outfit, has proposed a $400 million leveraged buyout for Health Net, and that the California Wellness Foundation, which owns 74 percent of Health Net stock, was mulling the matter.

Last week Health Net officials denied there was a done deal, and company spokesman Don Prial said the California Wellness Foundation couldn't hock its stock, under state guidelines.

"Our understanding is that they can only sell 5 percent of their stock next year, and up to 20 percent a year in the next three years," he said.

Prial said that Health Net Chairman and virtual founder Roger Greaves, 54, was adamantly opposed to a sale to Qual-Med. "Greaves said, 'I did not spend the last 11 years of my life building this company only to have it taken away from me,'" said Prial.

Confusing matters, the chairman of would-be buyer Qual-Med, Malik Hasan, was quoted in trade magazine Modern Healthcare as stating the acquisition would be formalized shortly, but Qual-Med officials declined to comment last week or even to confirm Hasan's quote in the trade magazine. Interestingly, former state Gov. George Deukmejian sits on the Qual-Med board.

Only six months ago, the state approved a plan, spearheaded by Health Net Chairman Greaves, to change the big HMO into a for-profit shop, after 11 years as a tax-protected non-profit operation.

After a great deal of controversy, Greaves and a team of 31 other high-ranking Health Net managers or board members bought a 24 percent stake in Health Net, the second-largest HMO in the state, for $300 million ($75 million down, and $225 million in notes). The $300 million will go the California Wellness Foundation.

The newly created California Wellness Foundation took the remaining 76 percent block of stock in the $1 billion-in-revenues Health Net.

Under state law, Greaves and the other buyers must pay into a charity the value of Health Net, and the California Wellness Foundation was created to accept that money.

The legal theory is that Health Net was built up tax-free, for charitable purposes, so that to convert to private ownership on a for-profit basis, buyers must compensate the state by creating a charity of equal value.

The final, $300 million deal wasn't what Greaves had in mind originally; initially he had proposed to the state that his investment team buy all of Health Net for $104 million.

Unclear last week was the power of Greaves and Health Net management to block a California Wellness Foundation stock sale to Qual-Med.

By some accounts, under a complicated buyout agreement approved by the state, the California Wellness Foundation needs approval of Health Net management to unload its stock. Greaves sits on the eight-member foundation board but is not chairman, as he originally proposed.

A state order dated Feb. 6, appears to limit California Wellness Foundation stock sales to 5 percent of the outstanding stock in 1993, 20 percent a year for the next three years, and then the remaining stock in 1997.

But Gordon Bava, California Wellness' lawyer at the Westside law firm of Manatt, Phelps, Phillips & Kantor, in brief comments last week said, "I wouldn't necessarily call it a showstopper," referring to Greaves' powers or state orders.

Officials at the foundation weren't talking much either. Howard Kahn, the president of California Wellness Foundation, last week said, "We have a policy of not commenting on questions" about negotiations with potential buyers of Health Net.

Qual-Med, in corporate literature, touts itself as being in the acquisition game. Its annual report is rife with highlighted quotes from company officers, such as "We have strengthened our administrative infrastructure in preparation for upcoming acquisitions," attributed to Linda Janda, Qual-Med's senior vice president of finance.

Qual-Med had its initial public stock offering last year and was legally advised by Skadden, Arps, Slate, Meagher & Flom, the law firm once so active with Drexel Burnham Lambert, the now-defunct brokerage house that virtually invented the big-time leveraged buyout in America.

Too, the Qual-Med annual report talks about cutting down health care costs. "We eliminated the blank check for testing. Under traditional insurance plans, it is easy for physicians to order batteries of tests, when only one or two would do the job as well," a quote attributed to William Popik, vice president of medical affairs.

As an HMO, Health Net provides health care to state employers. Typically, an employer will buy coverage from Health Net for employees, who then go to Health Net-designated doctors and hospitals for treatment.

Health Net, unlike industry giant Kaiser Permanente, does not have its own medical staff and buildings, but rather contracts with doctors and hospitals to treat enrollees. Like other HMOs, Health Net bargains with health care providers to hold down bills, and monitors performance of doctors.