TEXT-S&P cuts Care UK & Social Care Investments rating

Wed Nov 14, 2012 10:17am EST

Overview
     -- On Nov. 5, 2012, U.K.-based health care group Care UK acquired Harmoni 
for an enterprise value of GBP48 million plus associated costs.
     -- The acquisition will weaken Care UK's debt protection metrics to 
levels that we no longer view as commensurate with a 'B+' rating.
     -- We are lowering the corporate credit rating and senior secured debt 
ratings to 'B' from 'B+'. 
     -- The stable outlook reflects our estimate that the company will 
maintain Standard & Poor's adjusted EBITDA cash interest cover above 1.5x, 
while gradually improving EBITDA.

Rating Action
On Nov. 14, 2012, Standard & Poor's Ratings Services lowered its long-term 
corporate credit and senior secured debt ratings on U.K.-based health care 
group Care UK Health & Social Care Investments Ltd. to 'B' from 'B+'. The 
outlook is stable.

Rationale
On Nov. 6, 2012, Care UK announced that it had acquired Harmoni, a provider of 
out-of-hours health care services to the National Health Service (NHS) in 
England, for an enterprise value of GBP48 million. The rating action reflects 
that as a consequence of this acquisition, we estimate that Care UK's debt 
protection metrics will be significantly weaker for the next 12 to 18 months. 
As such, we no longer view them as commensurate with a 'B+' rating.

Following the announced acquisition, we have revised Care UK's financial risk 
profile to "highly leveraged" from "aggressive," reflecting management's 
greater willingness to incur additional debt and to accept a more highly 
leveraged balance sheet following the debt-financed acquisition. We estimate 
that for the year ending on Sept. 30, 2013, Care UK's Standard & 
Poor's-adjusted leverage will be about 6x, decreasing to between 5x and 5.5x 
in the year ending Sept. 30, 2014. These figures include about GBP325 million of
financial debt and about GBP134 million in the form of operating leases 
adjustments. 

The group's cash generation is likely to be temporarily impaired by about GBP100
million of cash outflow in 2003 as a result of the Harmoni acquisition and 
additional discretionary expansionary capital expenditure and development 
costs of about GBP52 million, which we understand will peak that year. We 
estimate the group should start to fully benefit from the combined scale from 
2014, when we anticipate that the combined entity will generate free cash flow 
of about GBP18 million. Despite this, the additional debt taken on as part of 
the acquisition will, in our view, weigh on Care UK's credit metrics in the 
near future.

In our opinion, the purchase will not in the short term materially improve 
Care UK's business risk profile, which we continue to view as "weak." The 
transaction fits well within the growing focus of the group on primary care as 
one of the pillars of its business. However, for it to meaningfully enhance 
EBITDA, in addition to the revenues from the existing Harmoni businesses (out 
of hours and offender health care services), the revenues achievable under the 
NHS 111 call service contracts will have to be realized over the next 12 to 24 
months. This could prove difficult, especially as the 111 phone line is a new 
health care service and will require full cooperation by all engaged parties, 
including the public, to work efficiently.

We view the transaction as an opportunity for Care UK to diversify and grow 
its business, but because it takes place at the time when the U.K. health care 
system is being overhauled, it comes with a high degree of uncertainty.

The ratings continue to reflect the group's relatively small size, focus on 
the U.K. market, and a certain degree of reliance on public funds, which are 
exposed to the vagaries of the U.K.'s political climate and changes in 
reimbursement policies. We take a negative view of the risks associated with 
independent sector treatment centers (ISTCs), including a lack of guaranteed 
procedure volumes priced at NHS tariffs.

These negative factors are partly offset by Care UK's good revenue 
predictability; a high proportion of its services are provided under forward 
contracts, especially in its residential care business. This is supported by 
the group's position as a leading operator of ISTCs and its entrenched 
position in the for-profit elderly and specialist care markets. Both of these 
markets are fragmented and consequently benefit larger operators with 
economies of scale. The group's record of winning healthcare tenders provides 
further support.

Liquidity
We currently assess Care UK's liquidity profile as "adequate" under our 
criteria (see "Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers," published on Sept. 28, 2011, on RatingsDirect on the 
Global Credit Portal). Our liquidity assessment is based on the following 
factors: 
     -- We estimate that Care UK's liquidity sources (including cash, funds 
from operations, and an available revolving credit facility ) over the 
next 12 months will comfortably exceed its uses by more than 1.2x. Even if 
EBITDA were to decline by 15%-20%, we expect that net sources would remain 
positive.
     -- On June 30, 2012, Care UK had an adjusted balance-sheet cash position 
of GBP29.3 million. However, nearly all of this cash balance has been used up to
purchase Harmoni.
     -- Its only financial debt is in the form of GBP250 million nonamortizing 
notes that mature in August 2017. Following the proposed bond tap, this will 
increase to GBP325 million.
     -- In connection with the acquisition, the group has increased its super 
senior revolving credit facility (RCF) to GBP97.5 million from GBP80 million due
2016. If the company successfully increases the amounts under the existing 
bond, we anticipate that the RCF should remain largely unutilized, apart from 
about GBP10 million in the form of performance bonds relating to certain health 
care contracts. The RCF documentation contains leverage and interest coverage 
maintenance covenants. As of June 6, 2012, the group has adequate headroom 
under these covenants and we estimate that this will remain the case for the 
next 12 months.
     -- Care UK's business model benefits from low working capital 
requirements and modest maintenance capital spending (about 2% of revenues).
 
Recovery analysis
The issue rating on Care UK's 9.75% senior secured notes due in 2017 is 'B'. 
The recovery rating on the notes is '3', indicating our expectation of 
meaningful (50%-70%) recovery prospects for note holders in the event of a 
default. Assuming that the proposed tap issuance is successful, the bond 
principal will increase to GBP325 million. 

The issue and recovery ratings on the senior secured notes are supported by 
the comprehensive security and guarantee package in place, and the favorable 
insolvency regime in the U.K. In addition, the ratings also incorporate our 
valuation of the company as a going concern, supported by a significant 
tangible asset base. Nonetheless, as a result of an increase in the 
super-senior revolver, which ranks ahead of the notes, we see a moderate 
decline in recovery prospects.

To calculate recoveries, Standard & Poor's simulates a hypothetical default 
scenario. Our simulated default scenario contemplates a default in 2015, 
assuming deterioration in the quality of the care homes, leading to lower 
occupancy rates and a significant drop in fees, reflecting the budgetary 
constraints of the U.K. government. We also assume the RCF to be fully drawn 
at the time of default and a 1.5% stress on interest rates on variable debt to 
account for a potential base rate increase and covenant breaches. 

We expect that most of the company's value will stem from its significant real 
estate portfolio asset base. We have therefore valued the company primarily 
using a discrete asset valuation. Our valuation is based on the company's 
balance sheet as of Sept. 30, 2012. We then adjusted the book value of the 
company's tangible assets upward, with an GBP85 million positive adjustment to 
account for a third-party market valuation dated 2010 of some of the company's 
properties. Finally, we applied haircuts to reach our gross stressed 
enterprise value of about GBP300 million. This figure includes some value for 
the recent Harmoni acquisition.

After deducting enforcement costs and priority liabilities of about GBP15 
million from our gross enterprise value, we arrive at a net enterprise value 
of about GBP285 million. From this, we deduct GBP101 million (GBP97.5 million
plus 
six months of interest) to reflect drawings under the increased RCF. 
Therefore, we assess recovery prospects in the 50%-70% range for the senior 
secured noteholders, hence our recovery rating of '3'. This assumes that the 
full amount of the bond is outstanding at default.
Outlook
The stable outlook reflects our view that Care UK should be able to balance 
potential fee and volume pressure against cost savings and new contract wins 
while maintaining its operating performance momentum, especially in its 
residential division. It also assumes that the company will successfully 
integrate Harmoni and achieve projected volumes under the new contracts and 
synergies stemming from merging the two business. By doing so, we believe that 
it should achieve EBITDA of about GBP60 million in 2013. This will cover by 1.5x
cash interest payments of about GBP32 million. We anticipate that the group will
achieve this despite potential U.K. government public spending cuts because of 
its size, leading market position, and diversified asset base.

We could take a negative rating action if adjusted EBITDA interest coverage 
were to drop significantly below 1.5x, or if Care UK proves unable to return 
to generating free operating cash flow of at least GBP10 million from 2014. 
Factors that could contribute to such a development include a failure to 
successfully execute a proposed integration strategy and achieve operating 
efficiencies and deliver projected volumes. The company's residential care 
division represents a less likely cause of a negative rating action in our 
view, as about 43% of its beds are on long-term block contracts.

In our opinion, a positive rating action is unlikely over the next 12-18 
months, due to Care UK's high adjusted leverage. This is estimated to be well 
above 5x, a level that we would not view as commensurate with a higher rating.


Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit 
Portal.
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings On Global Industrials 
Issuers' Speculative-Grade Debt, Aug. 10, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008


Ratings List
Downgraded; CreditWatch/Outlook Action
                                        To                 From
Care UK Health & Social Care Investments Ltd.
 Corporate Credit Rating                B/Stable/--        B+/Watch Neg/--

Care UK Health & Social Care PLC
 Senior Secured*                        B                  B+/Watch Neg
  Recovery Rating                       3                  3

*Guaranteed by Care UK Health & Social Care Investments Ltd.


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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