Why one of the largest U.S. hospital chains is dismantling itself

In early 2014, Community Health Systems vaulted into the top echelon of U.S. hospital companies with the $7.6 billion acquisition of Health Management Associates.

The addition of 70-plus hospitals gave the investor-owned company a tally of 206 across 29 states, making it bigger for the first time, at least by hospital count, than its up-the-road rival HCA Holdings.

And CEO Wayne Smith vowed to put the company's efficient management to work to turn around the HMA facilities whose doctors had fled and where operations were neglected as HMA management unsuccessfully fought to hold onto power against activist investor Glenview Capital Management.

The reverse has happened. Those HMA hospitals, still struggling and yet to be fully integrated, have plunged CHS into crisis.

Last week, the company confirmed that it has retained Wall Street advisers to perform a strategic review that could lead to the chain's sale or it selling off its 159 hospitals in big blocks.

Private equity group Apollo Capital Partners is rumored to be interested in some or all of CHS. The group entered the hospital business last year by purchasing RegionalCare Hospital Partners, which grew to 18 hospitals through the merger this year with Capella Healthcare to create RCCH HealthCare Partners.

CHS, which is based in the Nashville suburb of Franklin, doesn't have much choice but to consider breaking up its assets, said Larry Prybil, a University of Kentucky professor who has authored books on healthcare governance. “They're stuck,” Prybil said flatly.

CHS assumed $3.7 billion in HMA debt when it bought the Naples, Fla.-based chain and is now saddled with about $15 billion in debt, or about 6.5 times earnings before interest, taxes, depreciation and amortization (HCA's debt is 3.9 times EBITDA). That's despite raising $1.2 billion earlier this year through spinning off 38 small and rural hospitals into Quorum Health Corp. and the $445 million sale of its stake in a four-hospital joint venture in Las Vegas.

Worse, earnings and revenue have been falling since the autumn of 2015.

CHS is coming off a loss from continuing operations in the second quarter of $1.43 billion, or $12.90 per share, after taking a noncash write-down of goodwill on the sinking value of hospitals it bought over the years, including those acquired in the HMA deal. Excluding the one-time adjustments, adjusted EBITDA in the second quarter fell to $563 million compared with $769 million in the year-earlier quarter. Revenue also declined, by 6% to $4.6 billion.

The one saving grace is that CHS continues to have good cash flow with no major debt payments on the near-term horizon that might prompt a bankruptcy.

CHS declined to comment for this story.

Prybil said CHS not only has a debt problem but a strategic one. Its hospitals generally are spread all over the country, often in small markets or in third or fourth position against competitors in larger, growing markets, such as Florida, he said.

That geographic disparity, combined with debt-driven capital constraints, has made it difficult for CHS to build powerful, multihospital delivery hubs as Nashville-based HCA has done in markets such as Miami, Dallas and Houston. HCA brags that it has the No. 1 or No. 2 market-share position in the vast majority of its markets.

Neither has CHS pursued a strategy like LifePoint Health's. That smaller investor-owned chain has achieved consistent revenue and earnings growth by buying hospitals in smaller, fast-growing markets where the acquired hospital is the dominant, or in many cases, sole provider in town.

Instead, CHS is in many rural markets and too often is a bit player in crowded markets, including many where the company acquired hospitals in the HMA deal. Notable exceptions are the Fort Wayne, Ind., area, where it has eight hospitals and a breadth of ambulatory services, as well as the Oklahoma City area and markets in Mississippi and eastern Tennessee.

But the company has more than two hospitals in just eight major markets, representing a total of 56 hospitals, including many small ones.

In an interview with Modern Healthcare in May, Smith said the company was working to trim its holdings to a number that would allow it to focus its capital on strong-margin hospitals in sustainable markets and add more complex services in those markets.

“Where that takes you is not just having a core group of hospitals, you also have to think about all the outpatient and diagnosis facilities,” Smith said, including free-standing emergency departments, surgery centers and urgent-care centers.

The Quorum spinoff was an aggressive effort to get to that magic number, but it wasn't enough. During CHS' second-quarter earnings call with analysts in August, Chief Financial Officer Larry Cash said of 153 hospitals the company currently operates, the 61 former HMA hospitals continue to post revenue and earnings below that of its 92 legacy hospitals.

“That's the bulk of it,” said Jefferies & Co. senior healthcare analyst Brian Tanquilut, of the challenges dragging down CHS' operating performance.

Problems are particularly acute at some of the former HMA hospitals in Florida, where CHS has tried to buttress the facilities by recruiting more physicians and putting management attention there, Cash said.

Those efforts notwithstanding, the former HMA hospitals together posted 3% declines in revenue, surgeries and admissions in the second quarter, Cash said. In contrast, the company's legacy hospitals posted 3% gains in revenue and surgeries in the quarter, even with more than a 1% decline in admissions.

CHS has already found five buyers, including not-for-profit hospital systems, for 12 unnamed hospitals that are for sale, which surely include some of the former HMA facilities. Cash said those sales could yield $850 million.

Selling off some parts of CHS might be the best that management can hope for. No hospital chain is likely to buy the whole company and assume the same debt and operating issues that Smith and his management team have had to tackle, Tanquilut said.

And a private equity buyer, even one such as Apollo, faces the prospect of having to finance a deal that likely would surpass $20 billion by having to contribute up to 30% of the price in equity because of CHS' high debt level.

“It would be really challenging to buy the whole thing,” Tanquilut said.

Nashville healthcare attorney and dealmaker Dick Cowart of Baker Donelson said Smith and his board of directors should consider going private like HCA did a decade ago. CHS is worth far more than its current market capitalization of about $1.1 billion based on a share price of about $10, Cowart said. The company's stock traded at about $40 per share a year ago.

The price is so depressed that it's attracting bargain hunters such as Chinese billionaire Tianqiao Chen, who has accumulated 14.7 million shares of CHS in recent months and now holds a 12.9% stake in the company.

Going private through a leveraged buyout would allow a syndicate of investors to share the risk of new debt and give management time outside the unforgiving public markets to prune its operations and get back on track, he said.

In 2006, HCA was acquired in a leveraged buyout worth $21 billion by Kohlberg Kravis Roberts & Co., Bain Capital, Merrill Lynch and the Frist family, who founded the company. When the company returned to public ownership through an initial public offering five years later, it was a stronger, more focused company, Cowart said.

And that, Cowart added, may be the most expedient path for CHS to get out of its current mess. “Effectively, CHS is more valuable than the market thinks it's worth.”

—Harris Meyer contributed to this report