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July 19, 2013 01:00 AM

CHS stock drops sharply after subpoena and profit news

Beth Kutscher
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    Community Health Systems saw one of the largest drops among healthcare stocks Friday morning as investors digested the news of a new subpoena and admissions numbers that looked much worse than expected.

    The Franklin, Tenn.-based chain was trading down about 8% after disclosing in an earnings preview a day earlier that the U.S. Justice Department had handed down an additional subpoena as well as a request to interview two high-ranking executives in its two-year investigation into the company's admissions practices.

    The company also braced investors for earnings results that will be even lower than expected, including a sharp 57.2% decline in net income, which it attributed to weak patient volume, higher-than-expected bad debt and an adverse payer mix.

    The admissions numbers—a 5.7% drop in same-facility admissions and a 2.6% decline in adjusted same-facility admissions, a number which includes outpatient activity—come just days after HCA, the country's largest hospital chain, surprised Wall Street with its own upbeat earnings preview that surpassed expectations for patient volume and net income.

    “I think HCA will be your outlier,” said Brian Tanquilut, an analyst at Jefferies & Co. “HCA has differentiated themselves from everyone else.”

    Some of the difference may be due to HCA's urban focus compared with Community's more rural focus, Tanquilut said. He added that HCA is also more diversified, offering a greater number of ancillary services. “I think having a lot of side businesses basically opens up a lot of referral opportunities,” he said.

    HCA has also “made a very concerted effort to cut costs,” said Tom Gallucci, an analyst at Lazard Capital Markets. “It sounded like that worked out very well to their benefit.”

    In its announcement after market close, Community said it expects to report $65 million in net income on revenue of $3.2 billion for the second quarter, compared with net income of $151.7 million on revenue that was also about $3.2 billion during the same period last year. It is scheduled to report earnings July 29.

    The U.S. Justice Department opened its investigation into Community's admissions practices in April 2011, after Tenet Healthcare Corp.—in an attempt to thwart a takeover attempt—accused Community of improperly using short-stay admissions instead of observation.

    The latest subpoena comes after the second of two meetings that Community held this year with the government to “review and discuss the status of the investigation, the potential theories and defenses and the results of its joint medical necessity review.”

    But the feds want more documents supporting Community's position, requesting for instance its criteria for observation status and its financial relationships with physicians who have admitting privileges, the company said.

    The Justice Department also served “civil investigative demands” to interview two current employees, a division president and a senior VP, according to the company. Community said it will cooperate with the government's investigation.

    The bad news from Community also depressed shares of other publicly-traded hospital operators, including Health Management Associates, Naples, Fla., which was trading more than 4% lower this morning. HMA is also under scrutiny for its short-stay admissions practices, and received similar subpoenas in May and July 2011. The company used the same emergency department management software as Community.

    Community shares closed today at $43.16, representing an 8.77% decline. HMA closed at $15.65, a loss of 4.22%.

    The investigation is one issue that Glenview Capital Management raised in a campaign to unseat HMA's current board of directors and install nominees that may be more receptive to a change of control.

    While Community is rumored to be the lead suitor for a potential tie-up with HMA, the company said in its earnings preview that the negative second-quarter results have “intensified its focus on core operating strategies, volume initiatives and expense management”—which will likely heighten speculation about whether it has the focus and firepower for a deal.

    But Tanquilut said he thought Community's troubles might offer more incentive for the company to seek out the synergies a strategic transaction would offer. “It's going to prompt them to do a deal—I'm in that camp,” he said. “The only concern I have is financing.”

    Glenview, for its part, is moving forward with its consent solicitation process to replace HMA's current board.

    The hedge fund said on its Revitalize HMA website that its hand-picked nominees have met three times in the past several weeks “to establish committee structures and a transition plan to foster quality of care and continuity.” The group also tapped turnaround firm Alvarez & Marsal to conduct a review of HMA's operations.

    Glenview also disclosed that one of its nine nominees—Earl Holland, a former HMA vice chairman and chief operating officer—has withdrawn his candidacy (PDF).

    Follow Beth Kutscher on Twitter: @MHbkutscher

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