Corporate raiders and short sellers amass at the gates of Primary Health Care Limited

The stock looks set to move even higher after a broker note today lent credibility to rumors that private equity firms are interested in launching a takeover of the medical facilities operator.

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There’s nothing like takeover speculation and a short-squeeze to fire up a stock.

This is essentially why Primary Health Care Limited (ASX: PRY) is shooting the lights out today with the stock surging 7.5% to a five-year high of $5.48 ahead of the market close.

A short-squeeze refers to a rush by short-sellers to buy the stock. I’ll come back to this later.

It seems UBS’ latest research on Primary Health Care released today could be lending weight to rumors reported in the Australian Financial Review that private equity buyers are running the ruler over the pathology, diagnostic and general practice (GP) facilities owner.

Monday’s media report wasn’t taken very seriously but investors had a change of heart when UBS suggested that Primary Health Care’s new chief executive Peter Gregg could quite easily lift return on invested capital (ROIC) by 60 basis points (0.6 of a percentage point) by selling underperforming assets and reinvesting in the core business.

This is exactly the type of strategy private equity firms go for. These corporate raiders target companies where relatively quick fixes (such as change in corporate structure, debt profile or management systems) can unlock value.

According to UBS, some underperforming assets that could go under the hammer include the company’s medical software business HCN, health insurance arm Transport Health, its stake in Vision Eye Institute Ltd (ASX: VEI) and maybe even its diagnostic imaging division.

If the cash raised from the asset divestments is reinvested in Primary Health Care’s GP business, it could lift the company’s earnings per share by around 14%.

When you couple this with the fact that Primary Health Care is one of the most shorted stocks on our market, it makes for a fairly spectacular “pop” in the stock.

Short-selling data from the Australian Securities and Investment Commission shows that it is the sixth most shorted stock after embattled iron ore miner Fortescue Metals Group Limited (ASX: FMG).

Around 11.6% of Primary Health Care’s stock has been lent to short sellers as of March 25 (ASIC’s data is always a week old). In case you are curious, the most shorted stock is department store Myer Holdings Ltd (ASX: MYR).

Coming back to Primary Health Care, the stock has been targeted by short sellers on concerns that changes to the federal government’s funding for certain health programs will negatively impact on the company’s bottom line.

This is one bet that hasn’t paid off and there is no doubt that some short sellers are scrambling to buy back the stock to cover positions, adding a second wind to the stock’s performance today.

Given the amount of stock that could be bought back, short sellers could be fuelling Primary Health Care’s stock for some time yet.

Going by the average daily volume for the stock over the past year, short sellers will need about 22 days to replace the stock they borrowed.

Ouch!

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Motley Fool contributor Brendon Lau doesn't owns shares mentioned in this article. Follow me on Twitter - https://twitter.com/brenlau We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policyThis article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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