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TEXT-S&P rates Universal Health Services term loan 'BB+'
Overview -- U.S. hospital operator Universal Health Services is refinancing the balance of its term loan B, and repaying borrowings under its revolving credit facility and accounts receivable securitization program with a new $500 million term loan A-2. Debt levels are virtually unchanged. -- We are assigning our 'BB+' issue-level rating and '2' recovery rating to its proposed secured term loan. -- We are also affirming our ratings on the company, including our 'BB' corporate credit rating, our 'BB+' rating on its existing senior secured debt, and our 'B+' rating on its unsecured debt. -- Our stable rating outlook on Universal reflects our view that it will continue to benefit from low-single-digit organic growth and focus on growing its behavioral health segment so that its financial risk profile remains near its current level. Rating Action On Sept. 17, 2012, Standard & Poor's Ratings Services affirmed its 'BB' corporate credit, 'BB+' senior debt, and 'B+' unsecured debt ratings on King of Prussia, Penn.-based Universal Health Services Inc.. The '2' recovery rating on the senior debt and the '6' recovery rating on the unsecured debt remain unchanged. The outlook is stable. At the same time, we assigned a 'BB+' issue-level rating (one-notch above the corporate credit rating) and a '2' recovery rating to the company's proposed $500 million term loan A-2 debt due in 2016. The '2' recovery rating indicates our expectation of substantial (70%-90%) recovery for lenders in the event of default and the '6' recovery rating indicates expectations for negligible (0%-10%) recovery. Rationale The rating on Universal is based on our assessment of its business risk profile as "fair," reflecting the benefits of its increasing market presence and high margins in its rapidly growing inpatient behavioral business which somewhat eases the reimbursement risks associated with its less profitable acute care business segment. We consider the financial risk profile "significant," reflecting our expectation that leverage will remain in the low-3x area, and that the company will continue to follow a relatively modest growth strategy. Universal is an owner and operator of acute care hospitals, behavioral health hospitals, and ambulatory centers nationwide and in Puerto Rico and the U.S. Virgin Islands. Universal's recent results through mid-2012 are consistent with our expectations. The rating reflects our expectation that the hospital company's revenues in 2012 will grow by about 4% on a comparable basis, including the new accounting methodology for bad debt. This assumes the second half of the year is a little stronger than the first half due to a higher rate of growth in the behavioral health segment. We do not expect any acquisition-related growth in 2012, but do expect the pending acquisition of Ascend Health Corp. to be completed by the end of the year, adding about $200 million of revenue in 2013. For 2013, we expect revenue to increase by about 6.5%. We believe Universal will keep seeking small, accretive acquisitions of behavioral facilities that should help it sustain its overall growth rate near 5%. Universal's organic growth rate, which outpaces the 2% rise in 2012 GDP expected by our economists in their base case, is aided by Universal's solid growth in behavioral services patient volume, and its still-favorable mid-single-digit rate increases from private insurance companies at its acute care hospitals. Industry demand for behavioral services is strong, and generally more favorable reimbursement for behavioral hospitals tends to result in higher margins. We expect Universal's overall margins to remain relatively flat at about 18% as improving margins for the behavioral business offset declining margins of the acute care business. We expect leverage to remain relatively close to 3x for the next year, consistent with the range for a significant financial profile. Although we expect Universal to generate about $350 million of free cash flow, we expect the funding needs for the acquisition of Ascend (net of proceeds received for asset sales), and possibly a modest investment to repurchase shares, to limit the amount of debt repayment in 2012. We do not believe additional acquisition activity will be substantial because there are no real acquisition targets the size of Psychiatric Solutions, and we do not believe Universal will pursue a large acquisition in the acute care segment. Our view of Universal's "fair" business risk profile benefits from our perspective that, while Universal is subject to the uncertainties of reimbursement in both segments and still-high levels of uncompensated care in the acute care hospitals, these risks are diversified across two distinct businesses. We also assess the reimbursement risks associated with the behavioral health care segment, particularly as subsectors that generate strong margins may be targets for reimbursement cuts. Universal's hospital portfolio's focus primarily on two businesses--acute care hospital services and behavioral health care services--is unique. As of the quarter ended June 30, 2012, the behavioral health services segment now generates more revenue than the acute care hospital services segment. We expect the higher growth rate and greater acquisition focus for behavioral health services to continue, and that over time the behavioral segment will generate an increasing percentage of total revenues. The growth rate of the behavioral health segment exceeds 5%, compared with the acute care segment's recent 1% growth rate. We believe the majority of operating income is now generated by behavioral health services because of far superior margin compared with the acute care hospital segment. Liquidity Universal Health's liquidity is "strong." Sources of cash are expected to exceed uses over the next 12 to 24 months. Relevant aspects of Universal's liquidity are: -- We expect coverage of uses to average about 2.4x in the next 12 to 18 months. -- Sources of liquidity include about $835 million of funds from operations (FFO) before capital expenses and acquisition spending, cash and available-for-sale securities of $33 million, and about $600 million of availability on its revolving credit facility after outstanding letters of credit. -- We expect uses of liquidity to include some investment in working capital and acquisition spending that we believe could average about $200 million beginning in 2013. We expect capital expenditures of about $400 million in 2013. -- We expect Universal will have at least a 30% cushion for a total debt leverage covenant on its credit facility. The leverage covenant steps down 25 basis points (bps) in the first quarter of 2013. -- We believe the company has sound relationships with banks as the company has had ready access to the capital markets. -- Universal does not have any significant debt maturities until 2016. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Universal, to be published separately on RatingsDirect. Outlook Our stable rating outlook on Universal reflects our view that it will continue to benefit from low-single-digit organic growth and that it will continue to focus on the behavioral health segment as its key growth platform. We also do not expect Universal to deviate from its core competencies in its two segments and that it will not make any large, credit transforming acquisitions for the foreseeable future. We expect leverage to remain level at about 3.1x in 2012, and possibly decline to slightly below 3.0x by the end of 2013. If Universal reduces this level to the high-2x area and increase FFO to lease-adjusted debt to the high-20% area from the current level of about 22%, we could consider raising the rating. To achieve this, the company would have to overcome reimbursement pressure, increasing its EBITDA margin by about 100 bps with a revenue growth rate of at least 6%. If reimbursement weakens, or other industry factors such as local competition contribute to a 450-bp decline in its EBITDA margin to about 13%, or a more aggressive financial policy contributes to an increase in leverage to at least 4x, we would consider a lower rating. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Universal Health Services Inc. Corporate Credit Rating BB/Stable/-- New Ratings Universal Health Services Inc. Senior Secured US$500 mil term loan A-2 bank ln BB+ due 2016 Recovery Rating 2 Ratings Affirmed; Recovery Ratings Unchanged Universal Health Services Inc. Senior Secured BB+ Recovery Rating 2 Senior Unsecured 7% nts B+ Recovery Rating 6 Senior Unsecured 7.125% nts BB+ Recovery Rating 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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