TEXT-Fitch rates Community Health Systems proposed notes 'BB+/RR1'
Aug 8 - Fitch Ratings has assigned a 'BB+/RR1' rating to CHS/Community Health Systems Inc.'s (Community) $1.25 billion proposed senior secured notes due 2018. In addition, Fitch has assigned a 'B+' Issuer Default Rating (IDR) to CHS/Community Health Systems Inc; the Rating Outlook is Stable. The ratings apply to approximately $9.3 billion of debt at June 30, 2012. A full list of rating actions appears below. Community plans to use the proceeds of the proposed $1.25 billion of senior secured notes to retire a portion of its $2.2 billion credit facility term loan B due 2014. The senior secured notes are a new security in the capital structure and will be guaranteed on a secured basis by the same group of operating subsidiaries that are guarantors of the credit facility. The proposed notes will be first lien obligations secured by liens with equal rank on the collateral that secures the credit facility obligations. The senior unsecured notes rank effectively subordinate to the first lien obligations to the extent of the collateral securing the first lien obligations. THE 'B+' IDR PRIMARILY REFLECTS THE FOLLOWING: --Community's financial flexibility has improved in recent years. Calculated pro forma for its third-quarter 2012 (3Q'12) financing activities, debt-to-EBITDA has dropped to around 5.0x from 5.8x in 2008, the year immediately following the $6.9 billion acquisition of Triad Hospitals. --Liquidity is solid. The company has made substantial progress in refinancing its 2014-2015 debt maturities, free cash flow (FCF) generation is expected to be sustained above $300 million annually and 2012-2013 debt maturities are small. Fitch expects Community to continue to prioritize hospital acquisitions as a use of cash. --Organic operating trends in the for-profit hospital industry are weak and Fitch expects them to remain so in the second half of 2012. In the near term, Community's growth will be supported by its recent hospital acquisitions. --Community's patient admission policies and associated billing practices are facing heightened regulatory scrutiny and there is ongoing uncertainty about any potential financial or operating impact. SIGNIFICANT PROGRESS REFINANCING 2014-2015 DEBT MATURITIES Fitch had previously noted Community's 2014-2015 debt maturity wall as the most significant risk to its credit profile. Following a series of transactions over the past 18 months, Community has entirely refinanced its $3 billion 2015 notes maturity (pro forma for the company's planned redemption of the remaining $295 million 2015 notes on Aug. 18, 2012), and has reduced its 2014 term loan maturities to $1.2 billion, pro forma for the $1.25 billion reduction of the outstanding amount using proceeds of the proposed senior secured notes, from a previous $6 billion. Fitch believes that Community has adequate flexibility under its debt agreements and the market access necessary to refinance its remaining 2014 term loan maturities. An amendment to the credit facility executed last week enhanced the company's flexibility to address its remaining 2014 bank term loan maturities, through an increase in various incremental debt baskets, and a provision allowing the company to apply the proceeds raised under various of the baskets solely to reduce its 2014 term loan maturities. Community's liquidity profile is otherwise solid. Liquidity was provided by approximately $115 million of cash and marketable securities at June 30, 2012, availability on the company's $750 million bank revolver ($707 million available at June 30, 2012 reduced for outstanding letters of credit and $5 million drawn on the facility), and FCF ($348 million for the latest 12 months (LTM) ended June 30, 2012). Community generates solid cash flow relative to its operating and reinvestment requirements. Mostly due to higher capital expenditures, Fitch projects a lower level of FCF generation for Community in 2012 than in 2011, but expects that FCF will be sustained above $300 million annually. Debt maturities for 2012-2013 are small and include about $35 million and $75 million of required term loan amortization, respectively. DEBT SUSTAINED AROUND 5.0x EBITDA Pro forma for the proposed notes issuance and application of the proceeds to reduce term loan maturities, Fitch calculates total debt-to-EBITDA of 5.0x, including 2.7x through the bank debt, 3.3x through the senior secured notes and 5.0x through the senior unsecured notes. The company has a solid operating cushion under its bank agreement financial covenants, which require total debt-to-EBITDA maintained under 5.5x. While Community has not publicly stated a debt leverage target, Fitch thinks it is likely that the company is comfortable with total debt-to-EBITDA sustaining around 5.0x in the current operating environment. At June 30, 2012, the company's debt level is slightly above that of its publicly traded group of peer companies, but its higher debt levels have not hindered the company in its recent debt financing activities or limited its hospital acquisition opportunities. WEAK ORGANIC OPERATING TRENDS At June 30, 2012, Community operated 135 hospitals with about 20,200 licensed beds focused on non-urban markets across 29 states. Community is the sole provider in about 59% of its markets. This confers certain strategic benefits to the company, including the ability to leverage its controlling market share in pricing negotiations with commercial health insurers. At the same time, Community's relatively limited scope of services means that patients with more acute medical needs typically travel outside of its markets to tertiary medical facilities in nearby urban centers. Therefore, the company's patient utilization trends are susceptible to systemic issues affecting less acute types of patient services, such as the recent weakness in flu volumes and obstetrics services. Community's organic patient volume growth has lagged the broader for-profit hospital provider industry over the past couple of years. While Community's volume trends have shown some improvement in the first half of 2012, the trend continues to be fairly weak. Community's 2Q'12 same-hospital admissions were down 2% and same-hospital admissions adjusted for outpatient activity were up 0.5%. Despite the weak volume trend, the company has not lagged its peers in top-line and EBITDA growth. Strong pricing and an active hospital acquisition strategy have supported revenue and EBITDA growth. Community has managed to achieve consistent incremental growth in EBITDA in recent periods despite the margin impacts of integrating less profitable acquired hospitals. The 12.8% Operating EBITDA margin in 2Q'12 was down about 60 basis points from the 2Q'11 level. Community has publicly stated that it plans to acquire four-to-five hospitals per year. Year to date in 2012, Community has already met this target, acquiring four hospitals plus a large physician practice. In addition, Community has an outstanding letter of intent to purchase a two-hospital system with trailing revenues of $170 million. Community's 2011-2012 acquisitions will contribute $1.145 billion of trailing revenue, representing about 9.1% of the company's 2010 net revenues. HEIGHTENED REGULATORY SCRUTINY Since early 2011 Community's patient admission policies and associated billing practices have been the subject of heightened regulatory scrutiny. There is ongoing uncertainty about the potential for financial liability with respect to past billing practices or a reduction in the company's revenues and EBITDA resulting from changes in admissions practice. These regulatory issues will take some time to resolve in the interim period, and there is the concern that a reputational issue associated with the governmental inquiries could negatively affect operations. However, this does not appear to be the case in recent periods. Patient volume trends improved somewhat in the first half of 2012, the company is showing strong results in physician recruitment, and its acquisition opportunities have not diminished. POTENTIAL RATING TRIGGERS Based on Community's financial and credit metrics, there is limited upside potential in the ratings. An upgrade to the 'BB' category would require debt maintained at or below 4.0x EBITDA. Maintenance of the 'B+' IDR would be consistent with total debt-to-EBITDA at 5.0x and annual FCF generation of at least $300 million. A downgrade of the ratings could be the result of event risk surrounding an acquisition, or any potential financial liability stemming from the regulatory issues facing the company. Ongoing deterioration in organic operating trends or difficulties in integrating acquisitions could weigh on the credit profile if deterioration in EBITDA leads to debt levels maintained above 5.0x. The Recovery Ratings (RR) reflect Fitch's expectation that the enterprise value of Community will be maximized in a restructuring scenario (going concern), rather than a liquidation. Fitch uses a 6.5x distressed enterprise value (EV) multiple and stresses LTM EBITDA by 35%, considering post restructuring estimates for interest and rent expense and maintenance level capital expenditure as well as debt financial maintenance covenant requirements. The 6.5x multiple is based on recent acquisition multiples in the healthcare provider space as well as the recent trends in the public equity valuations of the for-profit hospital providers. Fitch estimates Community's distressed enterprise valuation in restructuring to be approximately $8 billion. The 'BB+/RR1' rating for the bank facility and senior secured notes reflects Fitch's expectations for 100% recovery under a bankruptcy scenario. The 'B/RR5' rating on the unsecured notes rating reflects Fitch's expectations for recovery in the 11%-31% range. Fitch has taken the following rating actions on Community: Community Health Systems, Inc: --IDR affirmed at 'B+'. CHS/Community Health Systems, Inc. --Assigned IDR of 'B+',; --Senior secured credit facility affirmed at 'BB+/RR1''; --Senior secured notes rated 'BB+/RR1''; --Senior unsecured notes affirmed at 'B/RR5'. The Rating Outlook is Stable. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 12, 2011); --'For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices' June 21, 2012; --'For-Profit Hospital Quarterly Diagnosis: First Quarter 2012' June 6, 2012; --'For-Profit Hospital Insights: Electronic Health Record Incentive Payments' March 7, 2012; --'2012 Outlook: U.S. Healthcare' (Dec. 7, 2011). Applicable Criteria and Related Research: For-Profit Hospital Insights: Electronic Health Record Incentive Payments For-Profit Hospital Quarterly Diagnosis 2012 Outlook: U.S. Healthcare -- Accelerating Regulatory and Fiscal Challenges For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices Corporate Rating Methodology
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