|[October 02, 2013]
Fitch Affirms Tenet Healthcare Corp.'s IDR at 'B'; Stable Outlook
NEW YORK --(Business Wire)--
Fitch Ratings has affirmed and removed the ratings of Tenet Healthcare
Corporation (Tenet) from Rating Watch Negative following the acquisition
of Vanguard Health Systems (Vanguard). The Rating Outlook is Stable. A
full list of rating actions follows at the end of this press release.
The ratings apply to approximately $10.2 billion of debt.
KEY RATING DRIVERS:
-- Tenet has acquired Vanguard, a competing for-profit hospital
operator, in an all-cash transaction valued at $4.3 billion. The
purchase price represents 7.7x Vanguard's June 30, 2013 latest 12 months
(LTM) EBITDA of $555 million. The acquisition was entirely debt funded,
resulting in pro forma leverage of 5.7x at June 30, 2013.
-- Fitch views the purchase of Vanguard as strategically sound because
it will enhance the geographic scope of Tenet's portfolio of acute-care
hospitals and add operational diversification through Vanguard's health
plan business. The strategic rationale for consolidation in the hospital
industry is encouraged by reforms favoring larger, integrated systems of
care delivery, including the Affordable Care Act (ACA).
-- The most important risks to Tenet's credit profile are the company's
strained free cash flow (FCF) and industry lagging profitability.
Vanguard has several large ongoing capital expansion projects, the
funding of which will further pressure cash flows in 2014-2015.
-- Given Tenet's somewhat limited financial flexibility and the high
degree of operating leverage inherent in the business model of a
hospital company, persistently weak growth in organic patient
utilization in the for-profit hospital sector is a concern.
-- Fitch believes the implementation of the health insurance expansion
elements of the ACA will be a positive catalyst for EBITDA growth for
the hospital industry starting in 2014, primarily because of a drop in
the number of uninsured patients and the associated financial burden of
bad debt expense.
VANGUARD ACQUISTION DRIVES HIGHER LEVERAGE
Tenet acquired Vanguard in an all-cash deal for a total consideration of
$4.3 billion, including the purchase of Vanguard's public equity for
$1.8 billion and the refinancing of $2.5 billion of Vanguard's net
outstanding debt. The transaction was entirely debt funded; Tenet issued
notes (including $1.8 billion 6% secured notes due 2020 and $2.8 billion
of 8.125% unsecured notes due 2022) to finance the acquisition.
Funding of the acquisition resulted in pro forma debt-to-EBITDA of 5.7x
for the combined entity, and total secured debt to EBITDA of 2.9x. Tenet
does have capacity for additional debt under its debt agreements,
although the capacity for debt secured pari passu to the notes is nearly
exhausted. The senior secured note indentures limit the company's
ability to issue additional secured debt. Secured debt is permitted up
to the greater of $3.2 billion and 4.0x EBITDA. Debt secured on a basis
pari passu to the secured notes is limited to the greater of $2.6
billion and 3.0x EBITDA. Considering the debt funding of the Vanguard
acquisition, Fitch estimates that Tenet has about $2 billion of
incremental total secured debt capacity and $150 million in pari passu
secured debt capacity.
LAGGING FCF AND PROFITABILITY
The most important risk to the credit profile is strained FCF (cash from
operations less dividends and capital expenditures) and industry-lagging
profitability. Although Tenet continues to lag industry peers in
profitability, the company's operating margins have recently improved,
helped by management's strategy to aggressively grow the relatively more
profitable outpatient business.
Expansion in FCF has also been aided by the recent refinancing of some
of the company's most expensive debt. Despite progress in improving the
business mix and reducing fixed interest expense, Tenet's FCF generation
remains thin ($7 million in the LTM ended June 30, 2013) and margin
expansion has stalled in recent quarters, as weak organic growth in
patient volumes has weighed on profitability.
The acquisition will further pressure FCF in the near term due to
Vanguard's elevated capital spending profile. Fitch expects Tenet to
generate positive but thin FCF in 2013-2014, with a FCF margin below 1%.
Vanguard is committed to capital investments in some of its recently
acquired markets. However, the funding of these projects will support
growth in EBITDA over the longer term. Some of the in-progress projects,
including a heart hospital in Detroit, MI and a general acute care
hospital in New Braunfels, TX, are scheduled to open in 2014, in time to
coincide with the health insurance expansion of the ACA.
While Fitch does not expect Tenet to encounter any major difficulties in
the integration of Vanguard it is worth noting that the company does not
have a track record of integrating larger acquisitions. Most of Tenet's
recent purchases have been small and focused on outpatient services.
Assuming a smooth integration process, operating synergies should
contribute to improved profitability post the acquisition. Tenet expects
to achieve $100 million-$200 million in cost synergies, with half of the
benefit realized by the end of the first full year post the acquisition.
While cost synergies are a proven component of return on investment in
hospital acquisitions, Fitch conservatively discounts the amount of
synergies Tenet expects to realize, with forecasted growth in EBITDA in
2014-2015 instead driven by the implementation of the ACA and organic
growth in the business helped by Vanguard's expansion projects.
AFFORDABLE CARE ACT POSITIVE DRIVER IN 2014
Fitch believes the implementation of the health insurance expansion
elements of the ACA will be a positive catalyst for EBITDA growth for
the hospital industry in 2014-2015, primarily because of a reduction in
uninsured patient volumes and the associated burden of bad debt expense.
However, modeling the ACA's effects for a combined Tenet/Vanguard is
difficult because of uncertainties in the assumptions of the
legislation's effects on the industry.
Beginning in 2014, there will be better visibility on te influence of
the ACA on the hospital industry. The open enrollment period for health
insurance plans offered in the insurance exchanges started on Oct. 1.
There was little information available beforehand about the expected
number of enrollees and the types of coverage these individual would
choose. There are also likely to be further development in the states'
Medicaid expansion plans. Post the acquisition, Tenet will have 27 of
its 77 acute-care hospitals in Florida and Texas, two states that do not
plan to expand Medicaid eligibility on Jan. 1, 2014. This will dampen
the positive effects of the insurance expansion provisions of the ACA
for the company.
WEAK ORGANIC OPERATING TRENDS
The for-profit hospital industry has been experiencing weak organic
operating trends since the trough of the 2007-2009 recession. Conditions
have been particularly challenging in the urban markets where Tenet and
Vanguard's hospitals are located because of higher levels of Medicaid
and uninsured patients (which are less profitable than those with
commercial health insurance). Vanguard is also highly exposed to trends
in Medicaid through the company's health plan business. The decision by
the state of Arizona to cut Medicaid payments rates to providers and cap
enrollment has recently been a headwind to that company's operations.
Fitch does not forecast an improvement in organic operating trends in
the hospital industry in the second half of 2013. In addition to weak
economic conditions, other factors including pressure by commercial and
government payors and a growing consumer share of healthcare spending
are constraining growth in healthcare utilization. The 2% sequestration
of Medicare payments and reforms to Medicare reimbursement required by
the ACA will also continue to weigh on top-line growth.
Maintenance of the 'B' IDR will require an expectation of debt-to-EBITDA
dropping to near 5.0x by mid-2015. There could be a tolerance for higher
leverage at the 'B' IDR (up to 5.5x total debt to EBITDA) assuming the
expectation of improvement in the FCF profile. An expectation of an
improving FCF profile could be supported by:
--Positive developments in the insurance expansion required by the ACA,
such as strong participation in the health insurance exchanges or more
state governments opting into Medicaid expansion;
--Evidence of some stabilization of organic operating trends in Tenet's
largest hospital markets;
--The on-time and on-budget completion of Vanguard's schedule of capital
The Stable Rating Outlook reflects Fitch's belief that the 5.0x leverage
target is achievable based mostly on EBITDA expansion driven by the ACA
and organic growth in the business, as opposed to the realization of
synergies or the application of cash to debt reduction. Given Tenet's
strained FCF, opportunities to pay-down debt are limited. The company
has recently been more aggressive in returning cash to shareholders, and
has indicated that it will continue to make share repurchases post the
acquisition. If the company chooses to fund share repurchase with debt
and delay deleveraging, it could result in a downgrade of the ratings. A
Positive Rating Outlook is unlikely over the next two-to-three years.
DEBT ISSUE RATINGS:
Fitch has affirmed Tenet's ratings as follows:
--Issuer Default Rating at 'B';
--Senior secured credit facility and senior secured notes at 'BB/RR1';
--Senior unsecured notes at 'B-/RR5'.
The Recovery Ratings (RRs) reflect Fitch's expectation that the
enterprise value of Tenet will be maximized in a restructuring scenario
(going concern), rather than a liquidation. The recovery analysis is pro
forma for the Vanguard acquisition, including the contribution of
Vanguard's EBITDA and the debt issued to fund the transaction.
Fitch estimates a post-default EBITDA for Tenet of $1.2 million, which
is a 35% haircut from the June 30, 2013 LTM EBITDA level of $1.8
billion. A 35% haircut represents roughly the level of EBITDA decline
that results in 1.0x coverage of Fitch's estimate of Tenet's fixed
charges adjusted for Vanguard in a distressed scenario, including
interest and rent expense and maintenance-related capital expenditures.
Fitch then applies a 6.5x multiple to post-default EBITDA, resulting in
a post-default EV of $7.6 billion for Tenet. The multiple is based on
observation of both recent transactions/takeout and public market
multiples in the healthcare industry. It represents a haircut from
recent transaction multiples, which have been ~8.0x, but is close to
recent public market multiples.
Fitch applies a waterfall analysis to the post-default EV based on the
relative claims of the debt in the capital structure. Administrative
claims are assumed to consume 10% of post-default EV. Fitch assumes that
Tenet would draw $400 million or 50% of the available capacity on the
$800 million revolver 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
The 'BB/RR1' rating for Tenet's secured debt (which includes the bank
credit facility and the senior secured notes) reflects Fitch's
expectation of 100% recovery under a bankruptcy scenario. The 'B-/RR5'
rating on the unsecured notes reflects Fitch's expectations of recovery
of 25% of outstanding principal.
The bank facility is assumed to be fully recovered before the secured
notes. The bank facility is secured by a first-priority lien on the
patient accounts receivable of all of the borrower's wholly owned
hospital subsidiaries while the secured notes are secured by the capital
stock of the operating subsidiaries, making the notes structurally
subordinate to the bank facility with respect to the accounts receivable
Total debt of $10.2 billion consists primarily of:
Senior unsecured notes:
--$60 million due 2014;
--$474 million due 2015;
--$300 million due 2020;
--$750 million due 2020;
--$2.8 billion due 2022;
--$430 million due 2031.
Senior secured notes:
--$1.041 billion due 2018;
--$1.8 billion due 2020;
--$500 million due 2020;
--$850 million due 2021
--$1.05 billion due 2021.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'The Affordable Care Act and Healthcare Providers: Assessing the
Potential Impact' (May 1, 2013);
--'Hospitals Credit Diagnosis' (Sept. 27, 2013);
--'High-Yield Healthcare Checkup' (Jan. 30, 2013);
--'2013 Outlook: U.S. Healthcare' (Nov. 29, 2012);
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
The Affordable Care Act and Healthcare Providers (Assessing the
Hospitals' Credit Diagnosis: Escalating Industry Consolidation Pressures
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S.
2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and
Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND
DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING
THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS.
AVAILABLE ON (News - Alert) 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
[ InfoTech Spotlight's Homepage ]