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A Rare Pricing Anomaly in the Healthcare Sector

It’s not like Wall Street to leave profits on the table. But they just did.

And if you’ll permit me to set the stage ever so briefly, I promise you’ll be able to use their ignorance to your ultimate advantage and profit.

You see, it’s a fact of investing that when a major acquisition is announced – for example, Steve Ballmer’s decision to go out with a bang at Microsoft (MSFT) and buy struggling handset maker, Nokia (NOK), for $7.2 billion – the “smart money” quickly ferrets out the implications of the deal (i.e. – the price per share for the acquired company). Then they scoop up shares before us less-informed investors have a chance to get in. Hence, Nokia opened 40% higher yesterday.

Likewise, when a company of Apple (AAPL) or Samsung’s (SSNLF) size and influence launches a new product, investors flock to sites like IHS iSuppli, which tears apart the new product to identify the maker of each component.

Why? Because investors know that if the product sells well, then every last company supplying parts for the product stands to benefit. And that instantly makes shares of the component suppliers surefire winners, too.

For some reason, though, the smart money is completely missing a new profit opportunity that just landed on my radar.

So it’s time we take advantage – and turn the tables on the smart money – before the opportunity disappears…

How to Turn a Disappointing Corporate Merger into Personal Profits

On July 30, the second-largest hospital chain in the United States, Community Health Systems (CYH), announced plans to buy Health Management Associates (HMA).

The purchase price? If we include assumed debt, it checks in at $7.6 billion, or $13.78 per share.

Like with all merger announcements, shares of Health Management naturally soared, right? Wrong! They actually dropped 10.8% on the news, going from $14.92 to $13.30. (Which could have cost some investors millions.)

We all know that the hospital business is notoriously low margin. But come on! Are conditions so bleak that there’s no value to be had here? Apparently so…

As Sheryl Skolnick at CRT Capital Group LLC told Bloomberg in the wake of the deal, “What will a knowledgeable buyer pay for your assets? You got the answer, less than the stock market.” And that’s because Health Management’s “fundamentals are so bad,” according to Skolnick.

As I write, though, Health Management’s stock is trading even lower, for only $12.90 per share. That means we can employ our trusty merger arbitrage strategy and earn a 7% yield by simply buying the stock and waiting for the deal to close in the first quarter of 2014.

And normally, I’d be content with a 7% merger arbitrage opportunity. Not in this case, though. Why? Because there’s an opportunity to earn even bigger profits without taking on any additional risk. And who doesn’t want that?

PSTX: An Undiscovered Arbitrage Opportunity

The biggest beneficiary of the tie-up between Community Health and Health Management actually promises to be a third party – Irvine, California-based Patient Safety Technologies (PSTX).

How do I know? Because I’ve been tracking Patient Safety – and its disruptive technology that prevents the most common surgical error in the United States – for over a year now. In turn, I’m intimately aware of its business dealings. (Case in point: My MicroCap Tech Trader subscribers are already up over 30% on this position. Go here to learn more.)

And guess what? Way back in September 2011, Patient Safety struck a deal with Community Health. And since that time, Community Health has rolled out Patient Safety’s SurgiCount Safety Sponge System at all 135 of its affiliated hospitals. (For confirmation, check out pg. 22 of Community Health’s year-end sustainability report.)

With that in mind, it’s a safe bet that Community Health will implement Patient Safety’s system across the 71 hospitals it’s acquiring from Health Management. After all, the technology does save lives and costs. And those are two things hospitals desperately need to do to stay in business nowadays.

So, what does this mean for Patient Safety?

Well, currently its technology is under contract for use in 295 hospitals, including seven of the top hospitals in the country, as rated by U.S. News and World Report. But once the deal closes between Community Health and Health Management, its “installed base” should quickly jump to 366 hospitals (or almost 25% higher) without lifting a finger.

And yet, even with this free growth in the pipeline, the stock didn’t budge an inch on the news. In fact, shares are trading at the exact same price they did on July 30 (when the deal was announced).

Wake-Up Call Coming

Why isn’t anyone on Wall Street connecting the dots here? It’s simple, really. Given Patient Safety’s diminutive market cap of only $78 million – and the fact that it doesn’t trade on a major exchange (yet) – the “smart money” remains virtually clueless to its existence, let alone the nuances of its business. Heck, only one other analyst even covers the stock.

But Patient Safety’s low profile doesn’t alter the reality of the situation one iota.

It stands to benefit the most from the deal between Community Health and Health Management. And I’m convinced that it’s only a matter of time before everyone else figures it out, too. Especially since the stock only needs to trade above $2 per share for 90 consecutive days to qualify for an “up-listing” to the Nasdaq. (It currently meets all other listing requirements.)

Bottom line: Wall Street’s ignorance never lasts long. And once the smart money connects all the dots here, Patient Safety promises to trade north of $2.50 per share. That represents at least a 25% upside to current prices, which sure beats the typical upside potential in a merger arbitrage deal. So don’t miss out.

Ahead of the tape,

Louis Basenese

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