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Fitch Affirms Community Health Systems' IDR at 'B+'; Outlook Negative
January 8, 2014 / 9:56 PM / 4 years ago

Fitch Affirms Community Health Systems' IDR at 'B+'; Outlook Negative

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(The following statement was released by the rating agency) NEW YORK, January 08 (Fitch) Fitch Ratings has affirmed Community Health Systems, Inc.'s (CHS) Issuer Default Rating (IDR) at 'B+'. The action follows a vote by the shareholders of Health Management Associates, Inc. (Health Management) approving an acquisition of the company by CHS. Fitch is also assigning a 'BB+/RR1' rating to CHS' proposed senior secured credit facility revolver, terms loans and senior secured notes, and a 'B/RR5' rating to the proposed senior unsecured notes. Proceeds will be used to fund the acquisition. A full list of rating actions follows at the end of this press release. The ratings have been removed from Negative Watch and assigned a Negative Rating Outlook. KEY RATING DRIVERS: --CHS will acquire Health Management in a cash and stock deal valued at about $7.4 billion, including the purchase of Health Management's public equity for $3.7 billion and the refinancing of $3.7 billion of Health Management's outstanding debt, plus a contingent value right (CVR) with a potential value of approximately $270 million. Fitch expects to withdraw the ratings on Health Management's outstanding debt upon the close of the transaction, expected to occur later in January. --Fitch believes that the strategic rationale for the transaction is sound. It will significantly increase CHS' operating scale, making it the largest operator of for-profit hospitals in the country based on number of facilities, as well as improve the company's geographic scope. --The addition of approximately $7.1 billion of debt to the capital structure will result in pro forma total debt-to-EBITDA approaching 6.0x at the close. Maintenance of the 'B+' IDR will require an expectation of debt declining to 5.0x EBITDA or below within 18 months following the transaction. --Fitch views the 5.0x leverage target as achievable and believes organic growth in EBITDA driven by the implementation of the Affordable Care Act (ACA) will contribute to deleveraging. Acquisition-related synergies are also expected to contribute to EBITDA growth. --Despite these growth drivers, Fitch expects that reducing leverage to 5.0x by mid-2015 will require CHS to apply the majority of free cash flow (FCF, cash from operations less capital expenditures and dividends) to debt reduction. --The Negative Outlook reflects risks in the companies' operating profiles that could impede deleveraging post-transaction. Both companies have been experiencing industry-lagging patient volume trends and are facing government regulatory investigations into Medicare billing practices. SOLID STRATEGIC RATIONALE SUPPORTED BY HEALTHCARE REFORM Fitch views the transaction as having a sound strategic basis for CHS because it will enhance the geographic scope of its portfolio of acute care hospitals and add scale. The rationale for consolidation in the healthcare provider industry is recently encouraged by reforms, including the ACA, favoring larger, integrated systems of care delivery. While the footprints of CHS and Health Management do overlap in 15 states, in most regions the two companies operate in different hospital markets. Revenue concentration in the top three states will improve to 32% from 40% on a stand-alone basis. Fitch does not expect CHS to encounter any major difficulties in the integration of Health Management; the company does have a track record of successfully integrating acquired hospitals. It has been several years since CHS' last sizeable transaction, of Triad Hospitals in 2007, but the company has made a series of smaller acquisitions of single hospitals or small hospital systems since that time. Cost synergies are a proven component of return on investment in hospital acquisitions, and assuming a smooth integration process, Fitch does expect synergies to contribute to growth in EBITDA in 2014-2015, although at a somewhat lower rate than the $250 million that CHS expects to achieve by the end of 2015. WEAK ORGANIC OPERATING TRENDS AND REGULATORY INVESTIGATIONS ARE A RISK The integration process could be hampered by operating challenges facing both companies. Both CHS and Health Management are facing government investigations, most of which are related to the issue of short-stay hospital admissions. During Q4'13, CHS booked a $101 million charge to earnings to reserve for a settlement of claims related to these investigations, providing some assurance that the size of the potential financial penalty will not appreciably impact financial flexibility. The scope and timing of any potential financial penalty related to the resolution of Health Management's regulatory issues is not known. The acquisition consideration includes a CVR of up to $1 per share, with a potential value of about $270 million. CHS will pay Health Management's shareholders the CVR in cash upon the final resolution of the regulatory investigations pending with the DOJ and SEC. The payment could be lower than $270 million if the settlement of the investigations involves a financial liability. Fitch expects final resolution of the investigations could take several years. The investigations are also contributing to lower EBITDA growth because of higher legal expenses and pressure on operating trends. Both companies have recently noted that a reduction in short-stay admissions is contributing to persistently weak growth in inpatient admissions. Health Management in particular has seen weak growth in its largest markets, with same-hospital growth in patient volumes lagging that of the broader for-profit hospital industry. Evidence of stabilization of patient volume trends in the combined company's largest hospital markets would support the credit profile. MEETING LEVERAGE TARGET WILL REQUIRE DEBT REDUCTION Funding for the transaction will add roughly $7.1 billion of debt to CHS' capital structure and drive pro forma leverage to nearly 6.0x at the close of the acquisition. Maintenance of a 'B+' IDR will require CHS to reduce leverage to below 5.0x within 12-18 months following the close. Fitch expects growth in EBITDA in 2014-2015 to contribute to leverage reduction; however, reducing leverage to 5.0x by mid-2015 will require CHS to apply the majority of free cash flow (FCF) to debt reduction. Fitch projects cash from operations of at least $1.6 billion for the combined company starting in 2014, and projects capital expenditures of around $1.2 billion, resulting in FCF of $400 million or greater annually. The top use of cash across the for-profit hospital industry has recently been hospital acquisitions, although most companies, including CHS, have used some cash for share repurchases over the past several years. A commitment by management to curtail shareholder-friendly capital deployment in favor of debt reduction over the 12-18 months following the acquisition would be supportive of the credit profile. RATING SENSITIVITIES: Maintenance of the 'B+' IDR will require CHS to reduce leverage to 5.0x by mid-2015. A downgrade could result if it appears likely that the company will not meet this target because cash deployment for acquisitions or shareholder payouts delays debt repayment, growth in EBITDA is hampered by difficulties in the integration of Health Management, or operating trends are weaker than expected. Drivers of a weak operating trend could include: --Weak macro-economic conditions in the combined company's largest hospital markets contribute to ongoing negative growth in organic patient volumes in 2014; --Persistent difficulties in the implementation of the ACA dampen the benefits of health insurance expansion for the hospital industry; --Headwinds related to the influence of the regulatory investigations weigh on topline and margins. A positive rating action is not anticipated before the end of 2015, since it would require the company to commit to maintain leverage at or below 4.0x. A revision of the Rating Outlook to Stable could occur near the end of 2014 if Fitch believes the company has made sufficient progress in debt reduction to achieve the 5.0x leverage target during 2015. Fitch has taken the following rating actions: Community Health Systems, Inc: --IDR affirmed at 'B+'. CHS/Community Health Systems, Inc: --IDR affirmed at 'B+', --Senior secured credit facility affirmed at 'BB+/RR1'; --Proposed $1 billion senior secured credit facility revolver rated 'BB+/RR1'; --Proposed $1 billion senior secured credit facility term loan A rated 'BB+/RR1'; --Proposed $2.3 billion senior secured credit facility term loan D rated 'BB+/RR1'; --Senior secured notes affirmed at 'BB+/RR1'; --Proposed $1.705 billion senior secured notes rated 'BB+/RR1'; --Senior unsecured notes affirmed at 'B/RR5'; --Proposed $2.875 billion senior unsecured notes rated 'B/RR5'. The Rating Outlook is revised to Negative from Stable. The debt issue ratings are based on a recovery analysis that is pro forma for the Health Management acquisition. The Recovery Ratings (RR) reflect Fitch's expectation that the enterprise value of CHS will be maximized in a restructuring scenario (going concern), rather than a liquidation. Fitch uses a 7.0x distressed enterprise value (EV) multiple and stresses LTM EBITDA by 30%, considering post-restructuring estimates for interest and rent expense and maintenance level capital expenditure as well as debt financial maintenance covenant requirements. The 7.0x 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 CHS' distressed enterprise valuation in restructuring to be approximately $13.7 billion. The 'BB+/RR1' rating for the bank facility and senior secured notes reflects Fitch's expectations for 100% recovery under a bankruptcy scenario. The 'B/RR5' rating on the unsecured notes reflects Fitch's expectations for recovery of 22%. The recovery waterfall assumes a fully drawn revolver at the proposed upsized amount of $1 billion. Contact: Primary Analyst Megan Neuburger Senior Director +1-212-908-0501 Fitch Ratings, Inc. One State Street Plaza New York, NY 10004 Secondary Analyst Jacob Bostwick, CPA Associate Director +1-312-368-3169 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug, 5, 2013) --'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013); --'Hospitals Credit Diagnosis' (Sept 27, 2013); --'The Affordable Care Act and Healthcare Providers: Assessing the Potential Impact' (May 1, 2013); --'High-Yield Healthcare Checkup' (Jan. 30, 2013); --'U.S. Leveraged Finance Spotlight Series: Community Health Systems, Inc.' (Oct. 1, 2012). Applicable Criteria and Related Research: Hospitals Credit Diagnosis: Operating Trends Remain Weak but Solid Liquidity Supports Credit Profiles here The Affordable Care Act and Healthcare Providers (Assessing the Potential Impact) here 2014 Outlook: U.S. Healthcare — Secular Challenges Require a Compelling Value Propositihere Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here U.S. Leveraged Finance Spotlight Series Community Health Systems, Inc. here High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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