In early January, Community Health Systems announced it would wait out the volatile market to spin off its $2.1 billion small-market hospital business. That wait could be awhile. But experts say even a protracted delay is preferable to launching a new company in a market that's in no mood for risk.
The proposed spinoff, Quorum Health Corp., would be a highly leveraged company with three dozen hospitals across 16 states and roughly $1 billion in debt, which the company will need to raise on its own. Investors, however, want little to do with companies burdened by ample debt as economic uncertainty and energy sector defaults have roiled markets.
That has left Quorum and other risky borrowers with few options in the debt market since the start of the year. Investors pulled $7.9 billion from funds that invest in risky corporate bonds in the first six weeks of the year, data from the Investment Company Institute show. “We understand that the debt markets have not been like this since 2008,” Community Health Systems CEO Wayne Smith said as the company announced its earnings last week.
Nonetheless, the Franklin, Tenn.-based company stood by its plan to spin off Quorum before July. “We expect to complete the spin once market conditions are favorable,” Smith said.
First investors must regain their appetite for risk, something that has been elusive since oil prices began their plunge. The drop in oil prices led to a spike in defaults among energy companies and “reminded investors that you can lose money,” said Christina Padgett, director of leveraged finance research at Moody's Investors Service.
Investor anxiety has been particularly acute this year. In January, corporate borrowers issued $7.8 billion in risky bonds, also known as speculative-grade bonds. That's down from $19.7 billion during the same month the year before, according to data compiled by the Securities Industry and Financial Markets Association.
The tight credit market is available only to the most solid, consistent companies that hope to issue speculative-grade bonds, said Paul Matlack, fixed-income strategist for Delaware Investments. Investors aren't interested in companies that do not deliver expected results. "You're looking for a company where you can sleep at night,” he said.
That is an issue for Community Health Systems, which is highly leveraged and missed expectations for its fourth quarter and saw its share price slide on the news.
The drop in Community Health Systems' shares, which began before the fourth-quarter results, compounds the challenge Quorum faces as it seeks to enter the debt market. The drop in equity values make it harder to borrow, said Dean Diaz, a senor vice president in corporate finance at Moody's.
Community saw its stock start to fall last year as benefits to hospital operators from the Affordable Care Act's health insurance subsidies began to taper off. Investor anxiety about highly leveraged companies also dragged down the stock.
That anxiety may subside for companies that are highly leveraged but are not in the energy and commodities sectors, particularly for companies with less exposure to economic conditions in China and Europe, Moody's Padgett said. Markets could rebound on the schedule set by Community's executives. “It's still a very nervous market, but it certainly seems possible,” she said.
However, Community Health Systems can afford to wait for better market conditions before spinning off Quorum, analysts said.
Companies don't face financial penalties for delaying spinoffs as they would with mergers or acquisitions. Community has also likely invested significant time and resources preparing to separate Quorum's operations.
“When you do a spinoff, you have done months and months of work,” said Philip Pfrang, global managing partner of Deloitte's healthcare and life sciences financial advisory practice. “You don't have the big bang occur at the date of the spinoff, and all of a sudden a flash of light and two separate companies.”
Few companies abandon a spinoff once it's announced.
Last year, two of the 164 spinoffs announced or pending were withdrawn, according to Thomson Reuters data. Globally, companies announced 195 spinoffs per year, on average, during the last decade. The number withdrawn reached double digits in only two years: 14 in 2011 and 13 in 2008. “I have been involved in quite a few spinoffs and I can't think of one that wasn't completed,” Prang said.
And the strategic reason for Community's spinoff remains attractive, analysts said.
Community pursued the spinoff for the same reason most companies do: to allow each company to focus on separate businesses and let investors value each on its own merits, said Emilie Feldman, an assistant professor of management at the Wharton School of the University of Pennsylvania who studies spinoffs. Typically, the value of a fast-growing business segment is masked by operations that have more sluggish results, she said.
Brian Tanquilut, a Jefferies analyst, said the Quorum plan “makes sense from a strategic perspective.” The newly created company will allow Community to focus on its strategy for remaining assets in large markets where the company hopes to build networks.
The deal is also expected to lower the company's leverage and shed some underperforming rural assets, “if they got it done," said Ana Gupte, an analyst with Leerink Partners. But for now, she said, the market challenges have made access to debt markets difficult.
