For-Profit Hospitals: Coming Up Lame

Rising costs and shrinking revenues are crimping growth

Until recently, for-profit hospitals have been hyped as the can't-miss business opportunity of the 21st century. With 75 million aging baby boomers about to depend on the health-care system, hospital executives spent the 1990s promising that the demand for such high-ticket procedures as knee replacements and heart surgeries would skyrocket. All the while, hospitals would cut costs by consolidating hundreds of independent players into superefficient chains that could churn out double-digit earnings growth year after year.

Turns out for-profit hospitals aren't quite such earnings machines. Analysts predict average earnings before taxes and other charges for the eight publicly traded hospital chains will drop 10% this year. True, much of the sorry performance is a result of Santa Barbara (Calif.)-based Tenet Healthca (HCA ) Corp., which revised its pricing practices after admitting it achieved much of its past growth by exploiting a Medicare loophole. Excluding Tenet, the for-profit hospital industry should grow 9.5%. That may not sound so bad, but it is a far cry from last year's 17% growth rate.

Indeed, when Tenet announced on June 23 that earnings for the year ending July, 2004, would be as much as 30% less than analysts' already lowered expectations, it cited unexpected costs and pressures largely unrelated to accounting. The same factors are dogging Nashville-based HCA, which already paid $1.7 billion in fines to settle federal fraud charges, but still announced first-quarter earnings that were half of what analysts expected.

Tenet's warning of weaker earnings reflects a host of troubling trends afflicting the entire for-profit hospital sector. Overall patient admissions fell 1% in the first quarter of this year -- the first drop in more than five years. That follows first-quarter increases of 1.5% in 2002 and 4.6% in 2001. The relentless nursing shortage, plus pressure from labor unions, is forcing some hospitals to boost salaries at record rates. And as they face protests from private health plans, and looming Medicare reform, hospitals are losing much of their pricing power. "There is a fundamental shift of power away from hospitals," says Sheryl Skolnick, analyst at research firm Fulcrum Global Partners LLC. "It's a shock to the system."

For the past five years, for instance, hospitals have foisted average price increases of 6% per year onto health plans, without much resistance. Now insurers are fighting back. WellPoint Health Networks (WLP ) Inc., the nation's second-largest insurer, collects data comparing treatment success with prices. If one hospital charges $1,000 to set a broken arm, for example, but a neighboring hospital that charges $500 has as many satisfied patients, WellPoint uses the data to negotiate lower rates from the pricier hospital.

Hospitals are also suffering from unexpectedly high labor costs. The Service Employees International Union, the nation's largest health-care workers union, has added 10 HCA and Tenet hospitals to its ranks since December -- more for-profit hospitals than it mobilized in the past two years combined. At one such facility, Tenet's Daniel Freeman Memorial Hospital in Inglewood, Calif., nurses were guaranteed salary increases of up to 29% over the next four years. "Some of them have never received raises that were that high. Ever," says SEIU spokesperson Lisa Hubbard.

Such added costs would be less damaging to the industry's bottom line if revenues were growing at a healthy clip. But the recent drop in patient admissions is a troubling sign that hospitals may be more vulnerable to economic declines than they claim to be. Sure, baby boomers are getting older, but analysts fear potential patients are delaying such elective procedures as knee replacements because they've lost their jobs or are afraid to take time off from work. That's bad news for the major hospital chains, which have been spending on new equipment to spruce up orthopedic centers and other services geared to aging patients.

For-profit hospitals are working hard to live up to their earlier promises. Many are deploying new computer systems to streamline payment systems and other administrative tasks. That could cut costs in the long run. But the fundamental challenges remain. Hospital chains may be doomed to trudging along at single-digit rates, rather than recapturing the speedier growth they once boasted. For investors hoping for so much more, that's a disappointing prognosis.

By Arlene Weintraub in Los Angeles and Charles Haddad in Atlanta

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