Rough financial market slows CHS' plans to spin off Quorum

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 38 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,” CHS CEO Wayne Smith said when the company announced its earnings last week.

Nonetheless, the Franklin, Tenn.-based system stood by its plan to spin off Quorum before July—as Smith put it, “once market conditions are favorable.”

Investors' appetite for risk sank as oil prices began their plunge. A spike in defaults among energy companies “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 the $19.7 billion issued during the same month in 2015, 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 CHS, which is highly leveraged, missed expectations for its fourth quarter and saw its share price slide on the news.

The drop in CHS' shares, which began before the fourth-quarter results were announced, compounds the challenge Quorum faces as it seeks to enter the debt market. The drop in equity values makes it harder to borrow, said Dean Diaz, a senior vice president in corporate finance at Moody's.

CHS 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.

However, CHS 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. CHS 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.”

And the strategic reason for CHS' spinoff remains attractive, analysts said.

CHS 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.

Typically, the value of a fast-growing business segment is masked by operations that have more sluggish results, she said.

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, a healthcare analyst with Leerink Partners. For now, she said, the markets are making that difficult.