Fitch Ratings has upgraded Tenet Healthcare Corporation's (Tenet) ratings, including the company's Issuer Default Rating (IDR), to 'B' from 'B-'. The Rating Outlook is Stable. The ratings apply to approximately $4.5 billion of debt at Dec. 31, 2011. A full list of rating actions appears at the end of this press release.
THE 'B' IDR PRIMARILY REFLECTS THE FOLLOWING FACTORS:
--While Tenet's liquidity and financial flexibility have recently improved, the company's ability to generate positive free cash flow remains strained.
--Otherwise, Tenet's liquidity profile is solid. Near-term debt maturities are limited and the company has adequate available liquidity in cash on hand and credit revolver availability.
--Organic operating trends in the for-profit hospital industry are weak, and Fitch expects weak patient utilization trends and the associated drag on top-line performance to persist throughout the rest of 2012.
--Tenet has made significant progress in improving its industry lagging profitability since 2008 and Fitch believes that Tenet has made some durable reductions to its cost structure.
POSITIVE TREND IN CREDIT METRICS
Tenet's credit metrics, including debt leverage and interest coverage, are strong relative to the 'B' IDR. Pro forma for a $300 million notes issuance last week, which resulted in a 0.3x increase in debt-to-EBITDA, Fitch calculates pro forma gross debt-to-EBITDA of 4.1 times (x) and EBITDA-to-LTM interest expense of 3.0x. Leverage through the secured debt is 2.4x. Tenet's gross debt-to-EBITDA has declined dramatically since 2007, dropping to near 4.0x from 6.5x.
The decline in debt leverage was entirely the result of growth in EBITDA primarily stemming from operational improvements. Operating EBITDA has expanded by 59% since 2008 as the result of 2.0% CAGR in revenue and a 390 bps expansion of the operating EBITDA margin. At 4.1x debt-to-EBITDA, Tenet's debt level is in the middle of the range of its peer companies, and Fitch does not expect the company to apply cash to debt reduction beyond some small note maturities in 2012 - 2013.
IMPROVING FINANCIAL FLEXIBILITY
During 2011, Tenet 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 Dec. 31, 2011 availability was $574 million).
The debt agreements do allow significant capacity for additional debt, including secured debt. Under the indentures covering the senior secured notes, 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. Fitch estimates that Tenet had about $1 billion of incremental capacity for debt secured on a basis pari passu to the senior secured notes and about $2 billion of total incremental secured debt capacity at Dec. 31, 2011.
STRAINED FCF PROFILE
Tenet's negative free cash flow (FCF, cash from operations less capital expenditures and dividends) profile remains the most important credit risk. In 2011, Fitch calculates FCF for Tenet of negative $2 million. The company's negative FCF in 2011 was influenced by an increase in accounts receivable due to the delay of state Medicaid payments and provider taxes and about $44 million of cash payments for litigation expense.
Fitch notes that the rate of cash burn has been steadily improving over the past several years, showing continued incremental progress in achieving positive cash flow. Fitch's projects that Tenet's FCF will be slightly positive in 2012 based in part on improved profitability and positive cash tax implications of a $1.8 billion net operating loss.
IMPROVEMENT IN OPERATING RESULTS
Tenet's patient volume growth trends shifted favorably beginning in 2011 and for 1Q'12, Tenet reports adjusted admissions growth of 2.8%, its sixth consecutive quarter of positive growth. Positive volume growth has helped the company improve its industry lagging profitability. Although Tenet continues to be less profitable than its peers, a 55 bps improvement in its Dec. 31, 2011 LTM EBITDA margin to 12.2% versus its 2010 EBITDA margin of 11.65% indicates that it is making incremental progress in closing the gap.
Since there are no apparent catalysts for near-term improvement in organic patient volumes, Fitch thinks patient volume trends in the for-profit hospital industry will remain weak throughout the rest of 2012. Trends that indicate higher levels of structural unemployment and growth in the consumer share of healthcare spending support an expectation of weak organic volume trends in the sector for some time to come. Continued strength in pricing will be critical to maintenance of profitability. There some concerning headwinds to the pricing outlook, particularly in government reimbursement rates (Medicare and Medicaid payors).
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. In 2011, Tenet spent $84 million on 15 outpatient facility acquisitions.
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 of an impact of topline growth as inpatient acquisitions because outpatient volumes generate less revenue. Outpatient volumes are typically, however, more profitable.
SHAREHOLDER FRIENDLY CAPITAL DEPLOYMENT
Tenet's capital deployment has recently become more shareholder friendly, as evidenced by use of the proceeds of a $300 million notes issue last week to retire preferred stock. The company has also deployed cash for share repurchases in recent periods. In 2011, Tenet spent about $375 million of cash on share buy-backs. This was the first time the company has bought back shares in recent history. During Q1'12 the company reports that it repurchased $26 million worth of shares.
GUIDELINES FOR FURTHER RATING ACTIONS
Maintenance of a 'B' IDR for Tenet would be consistent with credit metrics maintained at current levels, coupled with an expectation of sustained positive FCF generation. More clarity on Tenet's cash deployment strategy would also support the ratings in light of the company's recently more shareholder friendly capital deployment. A negative rating action for Tenet is unlikely in the near term but deterioration in the operating trend that results in lower profitability and ongoing negative FCF generation could result in a downgrade.
DEBT ISSUE RATINGS
Fitch has taken the following rating actions on Tenet:
--IDR upgraded to 'B' from 'B-';
--Senior secured credit facility and senior secured notes upgraded to 'BB/RR1' from 'BB-/RR1';
--Senior unsecured notes affirmed at 'B/RR4', previous rating 'B/RR3'.
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 affirmation of the unsecured notes rating at 'B' despite the upgrade of the IDR is based on a lower estimated distressed EV multiple. In its previous recovery analysis for Tenet, Fitch assigned a 7.0x multiple. 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 $4.9 billion. The 'BB+/RR1' rating senior secured bank facility and senior secured notes reflects Fitch's expectations for 100% recovery for these creditors. The 'B/RR4' rating on the unsecured notes rating reflects Fitch's expectations for recovery in the 31% - 51% range.
Total debt of $4.5 billion at Dec. 31, 2011 consisted primarily of:
Senior unsecured notes:
--$57 million due 2012;
--$216 million due 2013;
--$60 million due 2014;
--$474 million due 2015;
--$600 million due 2020;
--$430 million due 2031.
Senior secured notes:
--$714 million due 2018;
--$900 million due 2018;
--$925 million due 2019.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'For-Profit Hospital Quarterly Diagnosis: Fourth Quarter 2012' (April 25, 2012);
--'For-Profit Hospital Insights: Electronic Health Record Incentive Payments' (March 7, 2012);
--'2012 Outlook: U.S. Healthcare' (Dec. 7, 2011);
--'For-Profit Hospital Insights: Changes in Bad Debt Reporting Will Improve Disclosure' (July 26, 2011);
--'For-Profit Hospital Insights: A Review of Bad Debt Accounting Policies and Practices' (June 8, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
For-Profit Hospital Quarterly Diagnosis: Fourth-Quarter 2011
For-Profit Hospital Insights: Electronic Health Record Incentive Payments
2012 Outlook: U.S. Healthcare -- Accelerating Regulatory and Fiscal Challenges
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