TEXT - Fitch rates Tenet Healthcare secured notes
Jan 23 - Fitch Ratings has assigned a 'BB/RR1' rating to Tenet Healthcare Corp.'s (Tenet) 4.5% senior secured notes due 2021. The ratings apply to approximately $4.9 billion of debt at Sept. 30, 2012. The Rating Outlook is Stable. A full list of ratings follows at the end of this release. Tenet will use the proceeds of the $850 million senior secured notes issuance to retire $714 million of its 10% senior secured notes due 2018 in a tender offer. The balance will be used for general corporate purposes, including acquisitions, share repurchases and retirement of debt outstanding under its bank revolving credit facility. RATING SENSITIVITY/KEY RATING DRIVERS: --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). --Tenet's liquidity profile is otherwise 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 effect 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 company's fourth quarter 2012 (4Q'12) financing activities and assuming the retirement of the $714 million secured notes due 2018, Fitch calculates gross debt-to-EBITDA of 4.6x and EBITDA-to-interest expense of 3.1x. Leverage through Tenet's secured debt will increase to 2.8x EBITDA from 2.6x at June 30, 2012. Earlier in 4Q'12, Tenet announced plans to fund up to $500 million of share repurchases through the end of 2013 as well as up to $400 million of acquisitions. The company's issuance of $800 million in notes in October 2012, as well as this week's note issuance, will provide some dry powder for its capital deployment initiatives. However, Fitch believes further debt would be necessary to fully fund these objectives, since FCF is not anticipated to be a significant source of funds in 2013. 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 Sept. 30, 2012, availability was $430 million). Tenet does have capacity for additional debt under its debt agreements. The senior secured note indentures limit the company's ability to issue additional secured debt. Secured debt is permitted up to the greater of (i) $3.2 billion and (ii) 4.0x EBITDA ($4.6 billion at Sept. 30, 2012). Debt secured on a basis pari passu to the secured notes is limited to the greater of (i) $2.6 billion and (ii) 3.0x EBITDA ($3.5 billion at Sept. 30, 2012). Prior to this week's financing activities, Fitch estimated that Tenet has about $1.4 billion of incremental total secured debt capacity and $300 million in first lien secured debt 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 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 ended Sept. 30, 2012, Tenet produced FCF of negative $44 million. Although the company continues to consume cash, the degree of cash burn has improved significantly since 2006. The company's negative FCF in recent periods was influenced by an increase in accounts receivable due to the delay of state Medicaid payments and provider taxes, and higher cash payments for litigation expense. Fitch projects that Tenet's FCF will be about break-even in 2013. This projection is based on the reversal of some of the above-mentioned drags on cash generation and positive cash tax implications of a $1.7 billion net operating loss that the company brought on its books in late 2010. IMPROVEMENT IN OPERATING RESULTS Tenet's patient volume growth trends shifted favorably beginning in 2011 and, for 3Q'12, Tenet reported adjusted admissions growth of 1.4%, its eighth 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%-13%, 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. 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 an impact on topline growth as inpatient acquisitions because outpatient volumes generate less revenue. Outpatient volumes are, however, typically more profitable. Tenet currently generates only about one-third of its revenue from outpatient service, versus 50%-60% for its peer companies. 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 'B'; --Senior secured credit facility and senior secured notes 'BB/RR1'; --Senior unsecured notes 'B-/RR5'. 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. Fitch estimates Tenet's distressed enterprise valuation in restructuring to be approximately $5 billion. The 'BB+/RR1' rating on the 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 22% of outstanding principal. Total debt of $4.9 billion at Sept. 30, 2012 consisted primarily of: Senior unsecured notes: --$216 million due 2013; --$60 million due 2014; --$474 million due 2015; --$750 million due 2020; --$430 million due 2031. Senior secured notes: --$714 million due 2018; --$1.041 billion due 2018; --$925 million due 2019.
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