TEXT-S&P cuts Tenet Healthcare secured debt rating to 'B+'
Overview -- U.S.-based Tenet Healthcare Corp. is proposing to issue $500 million senior secured notes due 2020 and $300 million of unsecured notes due 2020. The company will use the proceeds to repay existing debt and for other purposes including acquisitions. -- We are revising the recovery rating on Tenet's existing senior secured debt to '2' from '1' and lowering the issue-level rating to 'B+' from 'BB-'. -- We are also assigning the new senior secured notes an issue-level rating of 'B+' with a '2' recovery rating, and the new senior unsecured notes an issue-level rating of 'CCC+' with a '6' recovery rating. -- The stable outlook reflects our expectation that Tenet's operating results will remain sluggish, with negligible free cash flow and little change to the company's "aggressive" financial risk profile. Rating Action On Oct. 1, 2012, Standard & Poor's Ratings Services lowered its issue-level rating on Dallas, Texas-based Tenet Healthcare Corp.'s senior secured term debt to 'B+' from 'BB-'. We revised our recovery rating on its senior secured debt to '2', indicating our expectation for substantial (70% to 90%) recovery for lenders in the event of payment default, from '1'. The revision of the recovery rating reflects our view of reduced recovery prospects for the term loan because of the increased amount of senior secured debt. At the same time, we assigned the new senior secured notes an issue-level rating of 'B+' with a '2' recovery rating (70% to 90% recovery expectation). We also assigned the new senior unsecured notes an issue-level rating of 'CCC+' with a '6' recovery rating (0% to 10% recovery expectation). All other existing ratings, including the 'B' corporate credit rating, are unchanged. The rating outlook is stable. Rationale The 'B' rating on Tenet Healthcare Corp. is based on Standard & Poor's Ratings Services' assessment of the company's business risk profile as "weak," reflecting significant reimbursement risk and a hospital portfolio with some concentration risk. We consider the financial risk profile as "aggressive," reflecting leverage near 5x as well as the company's ongoing inability to generate free cash flow. Tenet owns and operates 49 hospitals, over 100 free standing outpatient centers, and a subsidiary that provides business process solutions to health care providers. The rating reflects our expectation that the hospital company's revenues in 2012 will increase by about 4% compared with reported revenue in 2011. This estimation includes our assumption of a 3% organic growth rate, and one-time revenue recognition of a global Medicare legal settlement. In our view, Tenet's 2% growth in adjusted admissions midway through 2012 and still-favorable 5% to 7% rate increases from private insurance companies supports the company's organic growth. Year to date, revenues are up about 4%. We expect the adjusted EBITDA margin to remain little changed at about 13%, reflecting the company's efforts to offset reimbursement pressure with ongoing cost control efforts. We expect leverage to decline slightly from the current 4.9x level by the end of 2012. This is because we expect EBITDA in the second half of 2012 to be better than the first half because of certain expected revenue sources in the second half. For 2013, we expect revenue to increase by about 7%. Our expectation includes the same organic growth rate as in 2012 but also incorporates our view that Tenet will use proceeds from this latest financing for modest acquisition activity that will generate additional 3% revenue growth. We believe margins in 2013 could decline about 20 basis points (bps) to about 13%, and EBITDA may increase by only 4% compared with 2012 because of the absence of one-time revenues. This estimate includes our expectation for small Medicare rate increase, no Medicaid payment increases, and 5% rate increases by private insurance companies in 2013. We believe Tenet's acquisition activity may add about $300 million of revenue in 2013. Tenet's aggressive financial profile reflects the company's leverage and its poor cash flow generation. We expect Tenet to have a cash flow deficit of about $10 million in 2012, as defined by cash flow from operations minus capital expenditures. We expect cash flow in 2013 to be about flat. Tenet's cash flow has been negative for most of the past two years and may continue to impair Tenet's ability to pursue a larger growth strategy without having to rely on debt. In our view, Tenet's weak cash flow has lagged most of its peers. This historical lack of appreciable free cash flow generation relative to its size, coupled with our view of limited upside earnings potential because of the difficult reimbursement environment, and general market competitiveness, supports our view that debt reduction may be limited. We do not believe Tenet is in a position to pursue any shareholder-friendly programs without incurring additional debt and possibly increasing leverage. Although Tenet operates facilities in a fairly sizable number of markets, we view concentration risk as a key credit factor in our weak business risk assessment. Sixty three percent of the company's beds are located in only three states: Florida, California, and Texas. The exposure of California and Florida to the extended weak national economy, shown by their high unemployment and weak real estate trends, further highlights this risk. In addition, Tenet operates in several large markets, such as St. Louis, Philadelphia, and Houston, that we believe are quite competitive. This is a disadvantage when comparing Tenet with other peer hospital companies that focus on smaller, less competitive markets. Market competition for physicians, favorable managed care contracts, and the influence of a weak economy are all factors that contribute to Tenet's ongoing struggles to increase profitability. Liquidity Tenet's liquidity is adequate for its needs. Sources of cash are likely to exceed uses of cash over the next 12 to 24 months. Our assessment of Tenet's liquidity incorporates the following assumptions and expectations: -- With sources exceeding uses by more than $250 million, we expect coverage of uses to be about 1.9x in the next 12 to 18 months. -- Sources of liquidity include about $700 million of unadjusted operating cash flow before capital expenses and acquisition spending. -- In addition, we expect Tenet to have about $650 million of availability on its revolving credit facility after outstanding letters of credit. This assumes Tenet completes its pending transaction and repays the outstanding balance. -- Despite higher cash balances following the transaction, we expect cash to be rapidly deployed for acquisitions, and as a result, we are not counting the upcoming $360 million increase in cash as a source of liquidity. -- We expect uses of cash to include a moderate investment in working capital, and capital expenditures of about $500 million. -- With the completion of Tenet's pending debt transaction, the next significant debt maturities are in 2015, and there is only one financial covenant that is required only in the event that availability on its unrated revolver falls below $100 million. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Tenet Healthcare Corp., to be published shortly on Ratings Direct. Outlook Our rating outlook on Tenet is stable, reflecting expectations for continued sluggish operating trends and negligible free cash flow. We could consider raising the ratings only if Tenet can increase free cash flow to at least $200 million with prospects of at least that amount in subsequent years. This can be accomplished by growth in funds from operations, improvements in working capital, and reductions in other uses of cash when applicable, such as for legal costs and reserves, and possibly lower interest costs via debt refinancing. We believe the earliest this could occur might be 2014, only if Tenet's margin increases by more than 200 bps. This is a key consideration despite leverage below 5x. We would consider downgrading the company if its efforts to maintain its current financial risk profile and cash flow and liquidity weaken. In particular, an increase in leverage to the high-6x area due to revenue and margin pressure in the area of an estimated 400 bps margin decline, with limited prospects for improvement, would be an unexpected negative credit development. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009 -- Standard & Poor's Revises Its Approach To Rating Speculative-Grade Credits, May 13, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 Ratings List Ratings Unchanged Tenet Healthcare Corp. Corporate Credit Rating B/Stable/-- Senior Unsecured CCC+ Recovery Rating 6 Preferred Stock CCC Downgraded To From Tenet Healthcare Corp. Senior Secured B+ BB- Recovery Rating 2 1 New Rating Tenet Healthcare Corp. $500M sr secd nts due 2020 B+ Recovery Rating 2 $300M sr unsecd nts due 2020 CCC+ Recovery Rating 6 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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