Tenet Healthcare Corp. is starting to sound like a car dealer: We've moved all of last year's inventory to make way for the 2004 models!
Barely a week after announcing a deal to sell the last of the 14 hospitals slated for divestiture in March 2003, the company announced an even bigger sell-off: 27 hospitals, including 19 in its core California market. Santa Barbara-based Tenet expects to receive $600 million in total benefits from the sales, including the tax write-offs from losses on some sales.
Along with four other hospital closures or lease terminations that have been previously announced, the sell-off would slim Tenet from 100 hospitals to 69 hospitals. Trevor Fetter, Tenet's president and chief executive officer, said the restructuring goes beyond simple retrenchment.
"It's not about divestitures," Fetter said in a telephone interview. "It's about creating, from within, a core company that's an exciting company with growth."
For investors looking for that growth, however, Tenet had a message: Wait 'til next year, at least. The company will take $1.4 billion in charges related to the hospital sales in the fourth quarter of 2003, ended Dec. 31. Tenet also said it will fall far short of stock analysts' profit expectations both in that fourth quarter and in 2004.
Disputes with managed-care payers have landed $250 million in reimbursement claims in either arbitration or litigation, Tenet said. The company also expects bad-debt expenses to rise as a percentage of revenue in the fourth quarter from 11%, compared with 10% in the third quarter.
The bleak operating outlook and the second hospital sales plan in less than a year prompted some healthcare stock analysts to wonder if the next step for Tenet will be a full-scale breakup of the company.
Fetter, however, wouldn't even countenance the idea that this plan won't turn Tenet around.
"I can tell you why the company shouldn't break up. The core company as we've described it, 69 hospitals, is a good company. They're strong hospitals, good performers (in) good markets and always have been," he said, adding a moment later, "This size of the company is the size this company was seven years ago, and it was a very solid company."
Not-so Golden State
California's seismic-safety law is the prime motivation for the sales plans there, Tenet said. The 19 hospitals up for sale will need $1.6 billion to upgrade them to meet the law's first deadline, Jan. 1, 2008. The 17 California hospitals that Tenet plans to keep, by contrast, need only $300 million in upgrades, Tenet said.
By 2008, California hospital operators must ensure that their buildings will be able to withstand a major earthquake. The California Healthcare Association estimates that hospitals would need to spend $14 billion to upgrade their buildings by the deadline. A state survey estimated that 78% of California's 470 hospitals have at least one building on their campus that needs upgrading, said Jan Emerson, a spokeswoman for the association.
As a group, the 19 hospitals-all of which are in Southern California, except for Doctors Medical Center-San Pablo (Calif.)-haven't been tearing it up with their financial results, either. Tenet said they had revenue of $1.8 billion and losses of 2%, or about $36 million, in 2003.
The profile of underperforming hospitals with significant and immediate capital needs could keep the number of bidders for these hospitals down, said Jay Harris, an investment banker in the San Francisco office of Cain Brothers. "It is going to be very hard to do this as a bulk sale," Harris said. "There aren't any well-capitalized, aggressive systems acquiring hospitals in California these days."
Harris said he expects one-half to two-thirds of the hospitals to draw interest from local competitors as consolidation plays. "All or most of these facilities are in tough service areas, with fairly high Medi-Cal loads," Harris said, referring to California's Medicaid program.
For Tenet, "California is the perfect storm," said Pauline Clark, a director with the valuation firm Tellatin, Andreas & Short. The publicly available financial figures, including Medicare cost report data, for these hospitals don't tell much about their future prospects, Clark said. Those older figures don't include the cost of meeting the state's nurse-patient ratio law, which became effective Jan. 1, or the revenue loss from Tenet's revised policy on outliers, she said.
It's more of a mixed bag outside of California. Tenet said it is selling its three Massachusetts hospitals and one in Texas solely to exit those markets. Clark thinks the company could fetch a nice price for Brownsville (Texas) Medical Center because cost report data show it has a very good operating margin. The four hospitals that Tenet is selling in Louisiana and Missouri, however, are delivering losses that Tenet said it can no longer afford to carry. Overall, these eight hospitals took in $900 million in revenue in 2003 and broke even on operations, Tenet said.
Tenet faces plenty of challenges with the hospitals it is retaining, said Darren Lehrich, a healthcare stock analyst with SunTrust Robinson Humphrey. Lehrich was the first to report that industry sources were expecting a major divestiture plan from Tenet, a report that a Modern Healthcare Alert was the first to confirm last week.
The strategy that initially got Tenet into hot water-its rapid increases of its gross charges, or list prices-continues to plague the company with managed-care payers, Lehrich said. Because of those rapid increases, Tenet received a much higher-than-average amount of its Medicare revenue in the form of outliers-payments to offset the extra cost of treating the sickest patients. Health plans and hospitals often negotiate similar arrangements known as stop-loss provisions, and Tenet has taken a hit on these during renegotiations and claims disputes.
The outliers portion of this hit showed in Tenet's results for the first nine months of 2003: The company lost $308 million on $3.3 billion in revenue for the period, compared with profits of $328 million on $3.5 billion in revenue in the year-ago period.
Lehrich's expectations for Tenet were already low for 2004, but he said he was surprised that the company said it won't make any money on operations and will have a negative cash flow for the year. As a result of that darkening picture, Lehrich said, Tenet will have a very tight balance sheet well into 2005. He added that it will be six to nine months before anyone can tell whether Tenet will have to do more asset sales-in key markets this time-as the company looks "for cash to weather the storm."
Tenet's announcement showed that the situation is even worse than Jeff Villwock, a major Tenet skeptic, believed. Villwock is an adviser to Tenet's leading shareholder critic, M. Lee Pearce, and managing partner of Caymus Partners, an Atlanta-based investment bank.
First, Villwock said he expects that Tenet will find its bankers less willing to lend it money. Tenet said its operating results will break its covenant with banks that have made a $1.2 billion line of credit available to the company. Tenet has no cash borrowings under this credit facility. Second, Tenet's notoriety is starting to register with physicians and patients, with the company reporting last week that admissions grew only 0.7% in the fourth quarter "in the worst flu season of the last three years," Villwock said.
Tenet noted that admissions grew 1.5% in the 69 hospitals that it plans to keep.
Third, Villwock is concerned that much of the $600 million in benefits from the sales will come in the form of tax credits offsetting future profits because he doesn't see any chance of profits before 2006.
Finally, Villwock said the investigations of Tenet and the raft of malpractice lawsuits that it faces over allegations that physicians performed unnecessary procedures at Redding (Calif.) Medical Center will be the key to the Tenet story. He said the company's fate hinges on where the U.S. Justice Department takes its investigation of Medicare outliers. If prosecutors pursue fraud charges, the damages they seek could put Tenet out of business, he said.
"The only positive is your management team has to focus on only (69) hospitals instead of 100 hospitals," Villwock said. "I don't envy Trevor Fetter. He has a very, very, very difficult job right now."