Reader Comment: MEDITECH Litigation?

Pete made this comment:

"Love the writing. Just an FYI. With all this talk about litigation, check out MEDITECH'S SEC filings. A shareholder is suing them, a former director and founder of the company. Think the name is Grossman. Quite interesting."

Pete's right, although this isn't really "new" news. I'll explain what I've inferred from the SEC documents and earlier readings on the subject. I'm not an expert in these areas, so check the original sources and draw your own conclusions if it's important to you.

First, you should know that while MEDITECH is a large and profitable company, it is not publicly traded. It is required under SEC rules to submit certain publicly accessible documents because of its size and its profit sharing plan. Therefore, it cannot conduct its business in total anonymity as most non-publicly traded companies do.

Jerome H. Grossman was an original founder of MEDITECH, among others, some (most?) of whom are still with the company. His background is stunning: an MIT degree and Penn M.D., a member of the Institute of Medicine, former Chairman of the Federal Reserve Bank of Boston, former Chairman and CEO of New England Medical Center, and board member for several companies as well as the Mayo Foundation. Other than MEDITECH, he was involving in the founding of Tufts Associated Health Plan, Chartwell Home Therapies, and Transition Systems, Inc. (TSI.) He claims to have developed the world's first electronic medical record system while on the original staff of the Harvard HMO program. Credentialed enough for you?

Dr. Grossman holds about 1 million shares of MEDITECH (valuation to be discussed later.) This would represent about 3% of the outstanding shares. Barbara N. Grossman, whose address is the same, holds over 500,000 shares, or about 1 1/2%. Their combined family holdings are around 6% of the company, as reported by MEDITECH.

In April of last year, Dr. Grossman filed a complaint against MEDITECH and five of its six directors. He alleged that he was improperly terminated as a company consultant, that he was unfairly denied nomination to the company's board of directors, and that company directors rigged the market on MEDITECH's stock to keep its value artificially low so that Chairman and CEO Neil Pappalardo could buy it at a price below fair value.

Dr. Grossman submitted a shareholder proposal at the company's 2003 annual meeting. In it, he recommended that MEDITECH's board of directors obtain an impartial valuation of the company's stock, that stock transfer restrictions be removed, and that the company create a mechanism to allow shareholders to more easily buy and sell shares. He used Publix Supermarkets and SAIC as examples of large, non-publicly traded companies that have taken similar actions.

In addition, Barbara N. Grossman submitted a shareholder proposal that recommended having the board develop an open mechanism to consider any proposal of sale or merger of the company. The theme of both proposals was that MEDITECH's shares are undervalued and illiquid to its shareholders, depriving them of fair value.

MEDITECH's response was as follows:

• The board believes the share price has been fairly set.
• Share price has been reviewed by independent auditors, the Department of Labor, and the IRS without concern.
• Restrictions on share trading protect MEDITECH's interests by allowing only owners who have the company's success in mind.
• MEDITECH's conservative business practices made the company successful and will continue to do so.
• The board thinks the company is doing very well without a need to seek a buyer, and unsolicited expressions of buyer interest are entertained only as potential business partner relationships.

Both shareholder proposals were soundly defeated. MEDITECH filed a motion to dismiss legal action against the company and its directors. That motion was denied. I don't know the current status of the legal action.

What do I make of this issue? Well, first, the talent involved in the founding of MEDITECH is astronomical. These are some very, very smart and successful people who made extensive contributions (and continue to do so) beyond what they've done with MEDITECH. I'm in awe of the influence these pioneers have had, not only in healthcare automation, but in healthcare in general. And in doing so, they've made themselves fabulously wealthy and expanded their financial holdings into other companies and industries. If there was ever a success story of a bunch of really smart guys who made themselves rich, kept a low profile, retained the control and focus of their company, led an industry, and gave its customers a better mousetrap at a lower cost, MEDITECH would be it.

How wealthy could they be? Well, let's try to put a value on MEDITECH. Its annual sales are running around $260 million per year according to its 2002 SEC filings, and growing at 15% annually. The company has no long-term debt. If we look at the ratio of market capitalization to annual sales of MEDITECH's publicly traded competitors, we'd find Cerner at 1.9 times annual sales, Eclipsys at 2.8, and IDX at 2.0. If we call it 2.5 times, that means MEDITECH's market cap would be around $650 million, maybe more. Neil Pappalardo owns 26% of the company, so his shares could be worth around $170 million if you believe that valuation and if the company were publicly traded. Dr. Grossman's family's shares would be worth around $39 million. I'm no financial analyst, but these numbers seem reasonable. That means Neil Pappalardo's shares of MEDITECH are probably worth more than Neal Patterson's shares of Cerner.

From a purely financial standpoint, maybe it would make sense for MEDITECH to do what most companies their size would do: go public and reap the reward. Of course, you're also opening up your business to outsiders, losing control, guaranteeing your shareholders a roller coaster ride from one quarter to the next, and risking a major loss of focus. Personally, I admire MEDITECH for doing what they've done. They keep their costs low, their customers relatively happy, and themselves highly profitable. Surely you've heard the near-legendary stories of flea market furniture in their offices, their incessant avoidance of picking up dinner tabs, and lack of Taj Mahal-like displays at HIMSS. If you want to grab some entrees and drinks on the HIMSS exhibition floor, head for the Cerner compound, not MEDITECH.

What of the actions described above? I have no idea. Is it fair to Dr. Grossman or any other shareholder that the company hasn't unlocked potential value by selling out or going public? Or, on the other hand, why should Dr. Grossman's relatively small stake in the company overrule the vast majority of shares who voted to leave things as they are, regardless of their intention?

It's too bad the founders had a falling out, but business partners often do. At least they're fighting over a wildly successful company rather than a failing one. Regardless how it turns out, the story of MEDITECH and its founders is, to me, the most fascinating and awe-inspiring of any firm in our industry. Someone should write a book.