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Fitch Affirms Tenet Healthcare Corp.'s IDR at 'B'; Outlook Stable
September 20, 2017 / 5:16 PM / 3 months ago

Fitch Affirms Tenet Healthcare Corp.'s IDR at 'B'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, September 20 (Fitch) Fitch Ratings has affirmed Tenet Healthcare Corp.'s (Tenet) ratings, including the long-term Issuer Default Rating (IDR) at 'B'. The ratings apply to approximately $15.4 billion of debt at June 30, 2017. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Favorable Operating Profile: Tenet is among the largest for-profit operators of acute care hospitals in the U.S. and, following the acquisition of a majority interest in United Surgical Partners International (USPI) in 2015, also a leading operator of ambulatory surgery and imaging centers. The USPI transaction improved Tenet's payor mix and boosted its position in more profitable outpatient services. USPI also provides an offset to Fitch's expectation for flat to declining inpatient hospital volumes due to a secular shift toward lower-cost care. Lingering High Leverage: Debt funding of the USPI transaction prolonged the deleveraging horizon Fitch considered following Tenet's 2013 acquisition of acute care hospital operator Vanguard Health Systems, Inc. Deleveraging has been slow because it relies primarily on EBITDA growth. Tenet's weak free-cash-flow (FCF) generation has limited the company's ability to repay debt; at June 30, 2017 leverage (total debt/EBITDA after associate and minority dividends) was 7.5x. FCF Persistently Weak: Lower cash interest expense following the refinancing of high-cost debt as well as lower capital intensity due to the completion of several large hospital construction projects is contributing to slightly improving FCF (CFO less capital expenditures and after associate and minority dividends), but the level remains weak, both on an absolute basis and compared with the company's peer group. During 2016, Tenet spent $517 million on a litigation settlement. When adjusted for this one-time payment and a delay in certain payments from the state of California during 2017, LTM June 30, 2017 FCF would have been about negative $50 million. Activist Shareholder: Glenview Capital has an 18% ownership stake in Tenet, and in August 2017 two Glenview employees stepped down from Tenet's BOD, resulting in the suspension of a stand-still agreement with the company. Glenview has a history of instigating change in the hospital sector, most notably a proxy battle with Health Management Associates (HMA) that resulted in the re-seating of the Board of Directors and culminating in a sale of that company to Community Health Systems. Glenview has not made public any detailed plans about strategic objectives or priorities with respect to its ownership stake in Tenet, but Tenet's CEO has announced that he will resign in March 2018 or sooner if a replacement is selected. Operational Restructuring Plan: Tenet has been pruning the portfolio of hospitals through divestitures, and in early September management announced plans to sell another eight hospitals. A more comprehensive operational restructuring, including a sale of one of the operating segments, could be advanced by activist shareholders as a strategic option. The influence of such a transaction on the credit profile would depend upon the amount of proceeds raised, the use of the proceeds for various priorities including debt repayment, and the operational outlook for the remaining business. The terms of Tenet's debt agreements provide the company with a good deal of leeway in terms of asset sales and use of proceeds. Regulatory Uncertainty: Any policy to replace or reform the Affordable Care Act (ACA) that results in fewer insured individuals will result in a weaker payor mix for acute care hospitals, which would pressure margins unless offset by cost-saving measures or higher reimbursement through a rollback of the fees and payment cuts required by the ACA. Tenet's management has stated that the ACA has been a headwind to earnings considering its associated cuts to Medicare and Medicaid payments. DERIVATION SUMMARY Tenet's 'B' IDR reflects the company's highly leveraged balance sheet and weak FCF generation. The financial profile is similar to 'B' rated hospital industry peer Community Health Systems, Inc. (CHS). Both companies have high financial leverage as a result of large debt funded acquisitions made during 2013-2015. Tenet has a stronger operating profile than CHS. Like higher rated industry peers HCA Healthcare, Inc. and Universal Health Services, Inc., Tenet's hospitals are primarily located in urban or large suburban markets that have relatively favorable organic growth prospects. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Top-line growth of approximately negative 2% in each of 2017 and 2018; this assumes flat same hospital growth in the hospital operations segment and approximately 4% growth in each of the Conifer Health Solutions and ambulatory care segments, and includes the divestitures of the Houston and Philadelphia hospitals; --Operating EBITDA margin (Fitch's EBITDA calculation excludes income from affiliates) of 12.1% in 2017 and expanding slightly through the forecast period due to the divestiture of the lower margin Philadelphia hospitals, wind down of the health plan business and growth of the higher margin ambulatory segment's share of EBITDA. Fitch's 2017 EBITDA forecast assumes that the California provider fee program is approved late in the calendar year; --Tenet spends about $560 million to acquire Welsh, Carson, Anderson, & Stowe's remaining 15% interest in the USPI joint venture through the end of 2019; --Capital expenditures of $730 million in 2017 and capital intensity of 4% through 2020; --FCF (CFO less capital expenditures and associate and minority dividends) of about $150 million in 2017 and 2018-2020 FCF margin of slightly above 1%; --Total debt/EBITDA after associate and minority dividends is 7.1x at the end of 2017 and declines to about 6.5x by 2020 due to EBITDA growth and a small amount of proceeds from hospital divestitures used to repay debt. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action An expectation of gross debt/EBITDA after associate and minority dividends sustained near 5.5x and an FCF margin of 3%-4% could result in an upgrade to 'B+'. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action Gross debt/EBITDA after associate and minority dividends durably above 7.0x coupled with a cash flow deficit that requires incremental debt funding to complete the purchase of WCAS's ownership stake in USPI through 2019 are likely to cause a downgrade to 'B-'. This would most likely be accompanied by further deterioration in organic trends in patient volumes in the hospital operations segment. Fitch's current ratings case anticipates stabilization but not an improvement in trends. LIQUIDITY Generally Adequate Liquidity Profile: At June 30, 2017, liquidity was provided by $475 million of cash on hand and $998 million of availability on the $1 billion capacity bank revolver. Tenet's debt agreements do not include financial maintenance covenants aside from a 1.5x fixed-charge coverage ratio test in the bank agreement that is only in effect during a liquidity event, defined as whenever available asset-based lending (ABL) facility capacity is less than $100 million. LTM EBITDA/interest paid equalled 2.2x and is expected to improve slightly through the forecast period due to lower interest expense stemming from recent refinancing of some relatively high cost debt. Aside from the ABL facility, there is no floating rate debt in the capital structure, so exposure to rising interest rates is not a concern. Weak FCF Generation: Opportunities to reduce leverage through debt repayment are limited partly because Tenet does not consistently generate positive FCF. Industry lagging profitability and a high interest expense burden have been ongoing headwinds. In the LTM period ended June 30, 2017, Fitch calculates that FCF would have been about negative $50 million if adjusted for one-time items related to a litigation settlement payment of $517 million in late 2016 and the delay of a cumulative $110 million of supplemental Medicaid payments from the state of California. FULL LIST OF RATING ACTIONS Fitch has affirmed the follow ratings: Tenet Healthcare Corp. --Long-term IDR at 'B'; --Senior secured ABL facility at 'BB/RR1'; --Senior secured first-lien notes at 'BB-/RR2'; --Senior secured second-lien notes a t 'B-/RR5'; --Senior unsecured notes at 'B-/RR5'. The Rating Outlook is Stable. The 'BB/RR1' and 'BB-/RR2' ratings for Tenet's ABL facility and the senior secured first-lien notes reflects Fitch's expectation of 100% recovery for the ABL facility and 90% recovery for the $6.1 billion first-lien secured notes, respectively, under a bankruptcy scenario. The 'B-/RR5' rating on the $2.2B senior secured second-lien notes and $6.4 billion senior unsecured notes reflects Fitch's expectations of recovery of 22% of outstanding principal. The ABL facility is assumed to be fully recovered before the other secured debt in the capital structure. The ABL facility is secured by a first-priority lien on the patient accounts receivable of all the borrower's wholly owned hospital subsidiaries, while the first- and second-lien secured notes are secured by the capital stock of the operating subsidiaries, making the notes structurally subordinate to the ABL facility with respect to the accounts receivable collateral. Fitch estimates an enterprise value (EV) on a going concern basis of $7.8 billion for Tenet, after a deduction of 10% for administrative claims. The EV assumption is based on post reorganization EBITDA after dividends to associates and minorities of $1.2 billion and a 7x multiple. The post-reorganization EBITDA estimate is 43% lower than LTM EBITDA and considers the attributes of the acute care hospital sector including a high proportion of revenue (30%-40%) generated by government payors, exposing hospital companies to unforeseen regulatory changes; the legal obligation of hospital providers to treat uninsured patients, resulting in a high financial burden for uncompensated care, and the highly regulated nature of the hospital industry. During the early part of the past decade, Tenet's EBITDA dropped by more than half as a result of an operational restructuring to correct business practices in violation of Medicare standards. There is a dearth of bankruptcy history in the acute care hospital segment. In lieu of data on bankruptcy emergence multiples in the sector, the 7x multiple employed for Tenet reflects a history of acquisition multiples for large acute care hospital companies with similar business profiles as Tenet in the range of 7x-10x since 2006 and the average current trading multiple (EV/EBITDA) of Tenet's peer group (HCA, UHS, LPNT, CYH), which is about 8.0x and has fluctuated between approximately 6.5x and 9.5x since 2011. Fitch assumes that Tenet would draw $500 million or 50% of the available capacity on the $1 billion ABL facility in a bankruptcy scenario, and includes that amount in the claims waterfall. The revolver is collateralized by patient accounts receivable, and Fitch assumes a reduction in the borrowing base in a distressed scenario, limiting the amount Tenet can draw on the facility. Based on the definitions of the secured debt agreements, Fitch believes that the group of operating subsidiaries that guarantee the secured debt excludes any non-wholly owned and nondomestic subsidiaries and therefore does not encompass the value of the segments that is not owned by Tenet. At Dec. 31, 2016, Fitch estimates that about 74% of consolidated LTM EBITDA was contributed by the hospital operations segment and the portion of the ambulatory care segment owned by Tenet and uses this value as a proxy to determine a rough value of the secured debt collateral of $5.8 billion. Fitch assumes this amount is completely consumed by the ABL facility and the first-lien lenders, leaving $2 billion of residual value to be distributed on a pro rata basis to the remaining $800 million of first-lien claims and the second-lien secured and unsecured claims. Contact: Primary Analyst Megan Neuburger, CFA Managing Director +1-212-908-0501 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Britton Costa, CFA Senior Director +1-212-908-0524 Committee Chairperson John Kempf, CFA Senior Director +1-646-582-4710 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Summary of Financial Statement Adjustments - Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy 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 WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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