HCAs $33 billion leveraged buyout leaves it with little margin for error on two factors that are thinning profit margins for many hospitals: rising bad debt and weak patient volume.
Those trends will make it difficult for HCA to lower a net debt load that Wachovia Capital Markets estimates is $27.6 billion, analysts said. While HCA executives have emphasized that there are no plans to conduct major asset sales (Nov. 20, p. 4), a significant sale of assets is the only avenue open to HCA to make a big reduction in its debt load, said Dean Diaz, vice president and senior analyst with Moodys Investors Service.
The bad-debt and volume trends make it hard to boost profit margins, and HCA is already a lean operator of hospitals, so cost-cutting isnt likely to contribute much to expanding margins either, Diaz said.
Given the amount of debt, theres really no opportunity to de-lever through operations, Diaz said. The way we look at it, the only opportunity that they have to de-lever is either assets sales or, at some point, accessing the public markets again with an equity offering. Bad debt and soft volumes would probably have to worsen to force HCA to sell assets, Diaz added.
Capital expenditures are a source of cash that could be tapped, but not in great amounts, Diaz said. Hospitals need to invest in equipment to keep physicians loyal and admitting their patients, and not doing so risks patient volume, he said. Tenet Healthcare Corp., Dallas, struggled with that very problem when it trimmed capital expenditures while the government was investigating its Medicare outlier and physician recruitment strategies.
When Tenet announced a $900 million settlement of those investigations this summer, it also said that it would boost investment to win back physicians, particularly splitter physicians who admit patients to more than one hospital.
Selling 30 hospitals would reduce leverage about twice as much as four years of 2% annual growth in operating earnings would, assuming all the proceeds went to reduce debt, according to a research note by Miles Highsmith, a senior analyst with Wachovia. Leverage measures the ability of a company to pay off its debt by calculating the ratio of debt to a measure of operating earnings. In this case, the ratio compares net debt to earnings before interest, taxes, depreciation and amortization.
In securities filings, HCA estimates a compound annual growth rate in operating earnings of 3.8%. Those estimates, made before the buyout offer was announced, assumed that equivalent admissions growth would increase from 0.6% in 2006 to 1.3% in 2007 and then continue near that level through 2011.