Fitch Affirms Community Health Systems' IDR at 'B+'; Outlook Negative
NEW YORK -- January 8, 2014
Fitch Ratings has affirmed Community Health Systems, Inc.'s (CHS) Issuer
Default Rating (IDR) at 'B+'. The action follows a vote by the shareholders of
Health Management Associates, Inc. (Health Management) approving an
acquisition of the company by CHS. Fitch is also assigning a 'BB+/RR1' rating
to CHS' proposed senior secured credit facility revolver, terms loans and
senior secured notes, and a 'B/RR5' rating to the proposed senior unsecured
notes. Proceeds will be used to fund the acquisition.
A full list of rating actions follows at the end of this press release. The
ratings have been removed from Negative Watch and assigned a Negative Rating
KEY RATING DRIVERS:
--CHS will acquire Health Management in a cash and stock deal valued at about
$7.4 billion, including the purchase of Health Management's public equity for
$3.7 billion and the refinancing of $3.7 billion of Health Management's
outstanding debt, plus a contingent value right (CVR) with a potential value
of approximately $270 million. Fitch expects to withdraw the ratings on Health
Management's outstanding debt upon the close of the transaction, expected to
occur later in January.
--Fitch believes that the strategic rationale for the transaction is sound. It
will significantly increase CHS' operating scale, making it the largest
operator of for-profit hospitals in the country based on number of facilities,
as well as improve the company's geographic scope.
--The addition of approximately $7.1 billion of debt to the capital structure
will result in pro forma total debt-to-EBITDA approaching 6.0x at the close.
Maintenance of the 'B+' IDR will require an expectation of debt declining to
5.0x EBITDA or below within 18 months following the transaction.
--Fitch views the 5.0x leverage target as achievable and believes organic
growth in EBITDA driven by the implementation of the Affordable Care Act (ACA)
will contribute to deleveraging. Acquisition-related synergies are also
expected to contribute to EBITDA growth.
--Despite these growth drivers, Fitch expects that reducing leverage to 5.0x
by mid-2015 will require CHS to apply the majority of free cash flow (FCF,
cash from operations less capital expenditures and dividends) to debt
--The Negative Outlook reflects risks in the companies' operating profiles
that could impede deleveraging post-transaction. Both companies have been
experiencing industry-lagging patient volume trends and are facing government
regulatory investigations into Medicare billing practices.
SOLID STRATEGIC RATIONALE SUPPORTED BY HEALTHCARE REFORM
Fitch views the transaction as having a sound strategic basis for CHS because
it will enhance the geographic scope of its portfolio of acute care hospitals
and add scale. The rationale for consolidation in the healthcare provider
industry is recently encouraged by reforms, including the ACA, favoring
larger, integrated systems of care delivery. While the footprints of CHS and
Health Management do overlap in 15 states, in most regions the two companies
operate in different hospital markets. Revenue concentration in the top three
states will improve to 32% from 40% on a stand-alone basis.
Fitch does not expect CHS to encounter any major difficulties in the
integration of Health Management; the company does have a track record of
successfully integrating acquired hospitals. It has been several years since
CHS' last sizeable transaction, of Triad Hospitals in 2007, but the company
has made a series of smaller acquisitions of single hospitals or small
hospital systems since that time. Cost synergies are a proven component of
return on investment in hospital acquisitions, and assuming a smooth
integration process, Fitch does expect synergies to contribute to growth in
EBITDA in 2014-2015, although at a somewhat lower rate than the $250 million
that CHS expects to achieve by the end of 2015.
WEAK ORGANIC OPERATING TRENDS AND REGULATORY INVESTIGATIONS ARE A RISK
The integration process could be hampered by operating challenges facing both
companies. Both CHS and Health Management are facing government
investigations, most of which are related to the issue of short-stay hospital
admissions. During Q4'13, CHS booked a $101 million charge to earnings to
reserve for a settlement of claims related to these investigations, providing
some assurance that the size of the potential financial penalty will not
appreciably impact financial flexibility.
The scope and timing of any potential financial penalty related to the
resolution of Health Management's regulatory issues is not known. The
acquisition consideration includes a CVR of up to $1 per share, with a
potential value of about $270 million. CHS will pay Health Management's
shareholders the CVR in cash upon the final resolution of the regulatory
investigations pending with the DOJ and SEC. The payment could be lower than
$270 million if the settlement of the investigations involves a financial
liability. Fitch expects final resolution of the investigations could take
The investigations are also contributing to lower EBITDA growth because of
higher legal expenses and pressure on operating trends. Both companies have
recently noted that a reduction in short-stay admissions is contributing to
persistently weak growth in inpatient admissions. Health Management in
particular has seen weak growth in its largest markets, with same-hospital
growth in patient volumes lagging that of the broader for-profit hospital
industry. Evidence of stabilization of patient volume trends in the combined
company's largest hospital markets would support the credit profile.
MEETING LEVERAGE TARGET WILL REQUIRE DEBT REDUCTION
Funding for the transaction will add roughly $7.1 billion of debt to CHS'
capital structure and drive pro forma leverage to nearly 6.0x at the close of
the acquisition. Maintenance of a 'B+' IDR will require CHS to reduce leverage
to below 5.0x within 12-18 months following the close. Fitch expects growth in
EBITDA in 2014-2015 to contribute to leverage reduction; however, reducing
leverage to 5.0x by mid-2015 will require CHS to apply the majority of free
cash flow (FCF) to debt reduction. Fitch projects cash from operations of at
least $1.6 billion for the combined company starting in 2014, and projects
capital expenditures of around $1.2 billion, resulting in FCF of $400 million
or greater annually.
The top use of cash across the for-profit hospital industry has recently been
hospital acquisitions, although most companies, including CHS, have used some
cash for share repurchases over the past several years. A commitment by
management to curtail shareholder-friendly capital deployment in favor of debt
reduction over the 12-18 months following the acquisition would be supportive
of the credit profile.
Maintenance of the 'B+' IDR will require CHS to reduce leverage to 5.0x by
mid-2015. A downgrade could result if it appears likely that the company will
not meet this target because cash deployment for acquisitions or shareholder
payouts delays debt repayment, growth in EBITDA is hampered by difficulties in
the integration of Health Management, or operating trends are weaker than
Drivers of a weak operating trend could include:
--Weak macro-economic conditions in the combined company's largest hospital
markets contribute to ongoing negative growth in organic patient volumes in
--Persistent difficulties in the implementation of the ACA dampen the benefits
of health insurance expansion for the hospital industry;
--Headwinds related to the influence of the regulatory investigations weigh on
topline and margins.
A positive rating action is not anticipated before the end of 2015, since it
would require the company to commit to maintain leverage at or below 4.0x. A
revision of the Rating Outlook to Stable could occur near the end of 2014 if
Fitch believes the company has made sufficient progress in debt reduction to
achieve the 5.0x leverage target during 2015.
Fitch has taken the following rating actions:
Community Health Systems, Inc:
--IDR affirmed at 'B+'.
CHS/Community Health Systems, Inc:
--IDR affirmed at 'B+',
--Senior secured credit facility affirmed at 'BB+/RR1';
--Proposed $1 billion senior secured credit facility revolver rated 'BB+/RR1';
--Proposed $1 billion senior secured credit facility term loan A rated
--Proposed $2.3 billion senior secured credit facility term loan D rated
--Senior secured notes affirmed at 'BB+/RR1';
--Proposed $1.705 billion senior secured notes rated 'BB+/RR1';
--Senior unsecured notes affirmed at 'B/RR5';
--Proposed $2.875 billion senior unsecured notes rated 'B/RR5'.
The Rating Outlook is revised to Negative from Stable.
The debt issue ratings are based on a recovery analysis that is pro forma for
the Health Management acquisition. The Recovery Ratings (RR) reflect Fitch's
expectation that the enterprise value of CHS will be maximized in a
restructuring scenario (going concern), rather than a liquidation. Fitch uses
a 7.0x distressed enterprise value (EV) multiple and stresses LTM EBITDA by
30%, considering post-restructuring estimates for interest and rent expense
and maintenance level capital expenditure as well as debt financial
maintenance covenant requirements. The 7.0x multiple is based on recent
acquisition multiples in the healthcare-provider space as well as the recent
trends in the public equity valuations of the for-profit hospital providers.
Fitch estimates CHS' distressed enterprise valuation in restructuring to be
approximately $13.7 billion. The 'BB+/RR1' rating for the bank facility and
senior secured notes reflects Fitch's expectations for 100% recovery under a
bankruptcy scenario. The 'B/RR5' rating on the unsecured notes reflects
Fitch's expectations for recovery of 22%. The recovery waterfall assumes a
fully drawn revolver at the proposed upsized amount of $1 billion.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug, 5, 2013)
--'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013);
--'Hospitals Credit Diagnosis' (Sept 27, 2013);
--'The Affordable Care Act and Healthcare Providers: Assessing the Potential
Impact' (May 1, 2013);
--'High-Yield Healthcare Checkup' (Jan. 30, 2013);
--'U.S. Leveraged Finance Spotlight Series: Community Health Systems, Inc.'
(Oct. 1, 2012).
Applicable Criteria and Related Research:
Hospitals Credit Diagnosis: Operating Trends Remain Weak but Solid Liquidity
Supports Credit Profiles
The Affordable Care Act and Healthcare Providers (Assessing the Potential
2014 Outlook: U.S. Healthcare ￢ﾀﾔ Secular Challenges Require a Compelling
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
U.S. Leveraged Finance Spotlight Series Community Health Systems, Inc.
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S.
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Megan Neuburger, +1-212-908-0501
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Jacob Bostwick, CPA, +1-312-368-3169
Michael Weaver, +1-312-368-3156
Brian Bertsch, +1-212-908-0549 (New York)
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