When Tenet Healthcare Corp. in March announced a roster of 14 hospitals slated for sale or closure, the move was billed as a way to bolster its stock, which the company said was undervalued. The sale proceeds were to be used to aggressively repurchase Tenet shares, reducing the number in circulation and boosting the earnings-per-share figure the company would report, a key figure to many investors.
Three months later, as the Santa Barbara, Calif., company last week released a gloomy profit forecast covering the next 12 months, the potential hospital sales look more like a way to tread water. By the end of the year, Tenet said, the company needs to cut about $500 million off its debt load, valued at $4 billion on March 31, according to Tenet's most recent quarterly report. Tenet needs to reduce its debt to maintain a debt ratio level that is based in part on operating earnings, Tenet said.
Even with Tenet's move to shift available cash to paying down debt instead of buying back stock, Moody's Investors Service, New York, last week downgraded Tenet's ratings from investment grade to speculative. Standard & Poor's, New York, placed Tenet's ratings on CreditWatch for a possible downgrade.
The Moody's ratings change is "not expected to have any impact on our borrowing power or bank covenants or anything like that," Tenet spokesman Harry Anderson said.
Tenet also said last week that its board has elected a new director-John Kane, former vice chairman, president and chief operating officer of drug distributor Cardinal Health, Dublin, Ohio. Kane is the third new independent director elected this year. The four longest-serving directors-including Chairman and former Chief Executive Officer Jeffrey Barbakow-agreed to step down to change the makeup of the board. Barbakow plans to step down as chairman before Tenet's annual meeting on July 23.
Tenet's profit warning grew from the same root as most of the company's problems over the last eight months-rapidly rising gross charges, or list prices. Those rapid increases drove Tenet's Medicare outlier revenue to levels that are about four times the average hospital's, as a percentage of Medicare inpatient reimbursement.
The chain's profit forecast had to be sharply curbed because managed-care organizations are now refusing to give the company the 8% to 10% rate increases that its competitors are getting, Tenet said. In many managed-care contracts, gross charges help calculate stop-loss payments, which are similar to outlier payments. Both outlier and stop-loss payments are used to reimburse hospitals for patients whose treatment costs far exceed the average case.
Tenet negotiators didn't confront that firm bargaining position initially, but it has shown up in more recent negotiations, said Trevor Fetter, Tenet's president and acting CEO. "With some of the HMOs, we have accepted increases that are lower than we had originally anticipated because we wanted to preserve relationships and minimize disruptions at our hospitals," Fetter said in a telephone interview. Tenet is getting about half the increase that other hospitals are getting, he added.
Tenet's voluntary outlier reduction policy is expected to reduce its outlier revenue by $760 million for 2003, Tenet said. It expects revenue to fall to $13.6 billion in 2003, from $13.9 billion in 2002, while revenue per discharge is expected to decline 6.6% in 2003.
Tenet's profits are also being hit on the expense side. The company expects its health benefit costs to rise by 22% to $366 million. Malpractice insurance expense is rising by one-third, to about $320 million a year. The increase is not related to the investigation of two physicians at 188-bed Redding (Calif.) Medical Center (Nov. 4, 2002, p. 5), Fetter said.
The earnings forecast drew a rebuke from M. Lee Pearce, a shareholder and consistent critic of Tenet's management. Pearce again called for the management team to be replaced with experienced healthcare executives with no Tenet ties. In a statement, Pearce also questioned the plan to sell profitable hospitals at a time when Tenet needs "every dollar of earnings that it has" and might not receive good value for the hospitals.
Tenet is reaching the end of the process of soliciting bids on the hospitals, spokesman Anderson said. The company still expects multiple bids for the 12 hospitals still up for sale, Anderson said. Tenet already has announced that two of the hospitals will close, one because its lease is up and the other because buyers showed no interest.
Joshua Nemzoff, a transactions consultant, said last week's news doesn't change the business fundamentals of the hospitals up for sale. He did acknowledge that all the chains have less access to capital now, and that could reduce the number of acquisitions they make.