TEXT-Fitch cuts Tenet Healthcare notes to 'B-/RR5'
Oct 2 - Fitch Ratings has assigned the following ratings for Tenet Healthcare Corp.'s (Tenet) senior secured and unsecured notes: --$500 million 4.75% senior secured notes due 2020 'BB/RR1'; --$300 million 6.75% unsecured notes due 2020 'B-/RR5'. Fitch has also downgraded Tenet's outstanding senior unsecured notes to 'B-/RR5' from 'B/RR4'. The ratings apply to approximately $4.9 billion of debt at June 30, 2012. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. Tenet will use the proceeds of the $800 million notes issuance to retire $216 million of its 7.375% senior unsecured notes due 2013 in a tender offer and the balance for general corporate purposes, including acquisitions, share repurchases and retirement of debt outstanding under its bank revolving credit facility. THE 'B' IDR PRIMARILY REFLECTS THE FOLLOWING FACTORS: --While Tenet's liquidity and financial flexibility have incrementally improved, the company continues to exhibit industry lagging profitability and negative free cash flow (FCF, cash from operations less capital expenditures, dividends and distributions). --Otherwise, Tenet's liquidity profile is solid. Debt maturities are small until 2015, the company has adequate available liquidity in cash on hand and credit revolver availability and there are no financial maintenance covenants in affect under its debt agreements. --Weak organic patient utilization trends in the for-profit hospital industry have persisted despite the stabilization of unemployment rates. Fitch expects this trend to continue until the boost in patient volumes anticipated under the Affordable Care Act starting in 2014. --Fitch believes that Tenet's capital deployment strategy will become more aggressive in the near-term, focused on share repurchases and acquisitions that will likely require additional debt funding. DECENT HEADROOM IN CREDIT METRICS Tenet's credit metrics, including debt leverage and interest coverage, provide decent headroom relative to the 'B' IDR. Pro forma for the $800 million notes issuance and anticipated retirement of the $216 million notes due 2013, Fitch calculates gross debt-to-EBITDA of 4.9 times (x) and EBITDA to interest expense of 2.9x. Leverage through Tenet's secured debt will increase to 3.0x EBITDA from 2.6x at June 30, 2012. Debt is likely to trend slightly lower at the end of 2012 due slightly higher EBITDA in the second half of the year, this is due to the annualization of EBITDA contributed by the company' recent acquisitions, as well as the receipt of previously delayed Medicaid provider taxes. Tenet has announced that it plans to fund $400 million in acquisitions and $500 share million in share repurchases through the end of 2013. After the planned retirement of the $216 million of 2013 notes, Fitch anticipates that this week's debt issuance will provide some dry-powder for the company's capital deployment initiatives, but also expects that additional capital will be necessary to fund the entirety of the acquisitions and share repurchase plans. Since FCF generation is not expected to be a meaningful source of liquidity, Fitch believes that fulfillment of the capital deployment plan will require additional debt issuance. IMPROVING FINANCIAL FLEXIBILITY Tenet recently made progress in extending debt maturities and refinancing some of its higher cost debt. In November 2011, Tenet issued $900 million of 6.25% senior secured notes due 2018 and used a portion of the proceeds to refund the $714 million 9% senior secured notes maturing 2015. Also in November 2011, Tenet entered into an amendment to its credit facility, extending final maturity by one year, to November 2016. There is a springing maturity under the bank facility to fourth-quarter 2014 unless the company refinances or repays $238 million of its $474 million 9.25% senior notes maturing 2015. Tenet's debt agreements do not include financial maintenance covenants, except for a 2.1x fixed charge coverage ratio test under the bank facility that is in effect whenever availability under the revolver is less than $80 million (at June 30, 2012, availability was $445 million). The debt agreements do allow significant capacity for additional debt, including secured debt. Under the indentures covering the senior secured notes, secured debt is permitted up to the greater of $3.2 billion and 4.0x EBITDA. However, debt secured on a basis pari passu to the secured notes is limited to the greater of $2.6 billion and 3.0x EBITDA, or about $3.4 billion based on June 30, 2012 EBITDA. Following this week's $500 million secured note issuance, Fitch believes Tenet has basically exhausted this capacity. STRAINED FCF PROFILE While Tenet generates strong and consistent cash from operations, the company has been unable to generate positive FCF since the middle of last decade. Fitch believes that Tenet's inability to generate FCF stems from several issues, most notably including its industry lagging profitability and relatively high cash interest expense on some of its debt issues. While the company has made incremental progress in addressing these issues, its negative FCF profile remains the most important credit risk. In the LTM period ended June 30, 2012, Fitch calculates FCF for Tenet of negative $29 million. Tenet's FCF profile has recently also been influenced by some factors that are headwinds to cash generation for the entire for-profit hospital industry. These include higher capital expenditures, an increase in accounts receivable due to the delay of state Medicaid payments and provider taxes and higher cash payments for litigation expense. Due to Tenet's lagging profitability, however, the company's financial profile has been relatively less resilient to these stresses to cash flow. Fitch notes that the rate of cash burn has been steadily improving over the past several years, showing continued incremental progress in achieving positive cash flow. Fitch's projects that Tenet's FCF will be basically break-even in 2012 based in part on improved profitability, the receipt of previous delayed Medicaid provider taxes, a one-time settlement related to past Medicare billing practices and the positive cash tax implications of a $1.8 billion net operating loss. IMPROVEMNET IN OPERATING RESULTS Tenet's patient volume growth trends shifted favorably beginning in 2011 and for 2Q'12, Tenet reported adjusted admissions growth of 1.5%, its seventh consecutive quarter of positive growth. Positive volume growth has helped the company to improve its profitability. Tenet continues however, to be less profitable than its peers. The company's EBITDA margin in recent periods has hovered around 12%, which Fitch estimates is nearly 280 bps lower than the average of other publicly traded for-profit hospital operators. Tenet's recently improved level of profitability should be supported by its high level of outpatient healthcare services acquisitions. Starting in 2010, the company began a strategy of vertical integration in markets where it has an existing inpatient hospital presence, buying various outpatient assets, such as diagnostic imaging centers, ambulatory surgery centers and oncology centers. In 2011, Tenet spent $84 million on 15 outpatient facility acquisitions. This acquisition strategy is somewhat different than the current focus of Tenet's peer companies, which is to augment weak organic growth through the acquisition of inpatient acute-care hospitals. Outpatient acquisitions will not have as immediate of an impact of topline growth as inpatient acquisitions because outpatient volumes generate less revenue. Outpatient volumes are typically, however, more profitable. Tenet currently generates only about one-third of its revenue from outpatient service, versus 50 - 60% for its peer companies. SHAREHOLDER FRIENDLY CAPITAL DEPLOYMENT Tenet's capital deployment has recently become more shareholder friendly, as evidenced by use of the proceeds of a $300 million notes in 2Q'12 to retire preferred stock. The company has also deployed cash for common share repurchases in recent periods. In 2011, Tenet spent about $375 million of cash on share buy-backs. This was the first time the company has bought back shares in recent history. During the first half of 2012 the company reports that it repurchased $26 million worth of common shares. Earlier this week the company announced a new $500 million share repurchase authorization, to be completed by the end of 2013. The company also announced that it plan to fund up to $400 million of acquisitions. GUIDELINES FOR FURTHER RATING ACTIONS A positive rating action could result from a combination of the following: --An expectation of debt maintained below 5.0x EBITDA --A nearly 200 bps improvement in the EBITDA margin to around 14% --A FCF margin sustained around 3%, which is a level Fitch views as consistent with a 'B+' IDR for an operator of for-profit hospitals Continued successful execution of the company's acquisition strategy leading to growth in the proportion of revenues derived from more profitable outpatient volumes, as well as growth of Tenet's Conifer Health Solutions business are some potential drivers of financial improvement that could result in an upgrade of the ratings. A negative rating action could result from a combination of the following: --An expectation of debt maintained above 5.5x EBITDA --A deterioration in recently improved profitability --Persistently negative FCF generation, particularly if this coincides with an amelioration of the FCF headwinds affecting the broader for-profit hospital industry Deterioration in the financial profile leading to a negative rating action would likely be the result of poor organic performance in Tenet's major markets. The company is heavily exposed to Florida and Texas (about 45% of licensed beds), where Medicare payments to providers have been particularly stressed, although Fitch believes the trend of declining Medicaid payments has bottomed. DEBT ISSUE RATINGS Fitch rates Tenet as follows: --IDR affirmed at 'B'; --Senior secured credit facility and senior secured notes affirmed at 'BB/RR1'; --Senior unsecured notes downgraded to 'B-/RR5' from 'B/RR4'. The recovery ratings (RR) reflect Fitch's expectation that the enterprise value of Tenet 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. 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. The downgrade of the unsecured notes rating is based on lower expected recovery for the holders of these notes pro forma for the upsizing of debt in the capital structure by $584 million following this week's $800 million note issuance and the tender for the $216 million 2013 notes. Fitch estimates Tenet's distressed enterprise valuation in restructuring to be approximately $4.7 billion. The 'BB+/RR1' rating senior secured bank facility and senior secured notes reflects Fitch's expectations for 100% recovery for these creditors. The 'B-/RR5' rating on the unsecured notes rating reflects Fitch's expectations for recovery of 15% of outstanding principal. Total debt of $4.9 billion at June 30, 2012 consisted primarily of: Senior unsecured notes: --$216 million due 2013; --$60 million due 2014; --$474 million due 2015; --$600 million due 2020; --$430 million due 2031. Senior secured notes: --$714 million due 2018; --$1.041 billion due 2018; --$925 million due 2019. Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors. Applicable Criteria and Related Research: --'Hospitals Credit Diagnosis' (Sept. 18, 2012); --'Corporate Rating Methodology' (Aug. 8, 2012); --'For-Profit Hospital Insights: Annual Review of Bad Debt Accounting Policies and Practices' (June 21, 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: Hospitals Credit Diagnosis: Operating Trends Remain Weak but Solid Liquidity Supports Credit Profiles Corporate Rating Methodology For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices For-Profit Hospital Insights: Electronic Health Record Incentive Payments 2012 Outlook: U.S. Healthcare -- Accelerating Regulatory and Fiscal Challenges
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