Fitch Rates Prime Healthcare Foundation, CA 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an implied general revenue obligation rating of 'BBB+' to Prime Healthcare Foundation, CA (PHF).

The Rating Outlook is Stable.

SECURITY

Bond payments are secured by a pledge of the gross receivables of the obligated group. Additional security is provided by a mortgage on seven PHF hospitals and a negative pledge on the other hospitals.

KEY RATING DRIVERS

LOW DEBT BURDEN: PHF's light debt burden, with maximum annual debt service (MADS) equal to 1.1% of fiscal 2015 operating revenue, allows for solid MADS coverage despite modest historical operating profitability and is primarily a result of the organization's receipt of debt free hospital donations from PHSI. It is the expectation that leverage will remain low over the near term.

MANAGEMENT TEAM EXPERIENCE: PHF's senior management team is the same as Prime Healthcare Services, Inc. (PHSI), a large, multi-state for-profit health system. As such, PHF's senior management team has significant experience in hospital operations and specializes in turning around financially troubled hospitals.

STRONG LIQUIDITY RELATIVE TO DEBT: Given PHF's low leverage, liquidity metrics are strong relative to debt with 250% cash to debt and 42.2x cushion ratio at Dec. 31, 2015, easily exceeding Fitch's 'BBB' category medians of 89.5% and 11.1x, respectively.

MODEST PROFITABILITY: Operating profitability has been light with operating EBITDA margin averaging 6.3% since fiscal 2012 and equal to 6.0% in fiscal 2015. However, the pro forma impact of four new hospitals added to PHF in fiscal 2016 and one hospital expected to be acquired in fiscal 2016 materially compresses operating profitability based on historical results.

RATING SENSITIVITIES

SUCCESSFUL INTEGRATION OF NEW HOSPITALS: The 'BBB+' rating reflects Fitch's expectation that Prime Healthcare Foundation will successfully integrate the new hospitals, reducing associated operating losses, and improving consolidated cash flows to provide for coverage consistent with the rating. Successful integration of the new hospitals resulting in strong coverage could result in positive rating action. Conversely, delayed turnaround of the new hospitals could result in negative rating action.

FUTURE ACQUISITION ACTIVITY: PHF will likely continue to grow through acquisitions and/ or additional donations from PHSI. The related rating impact will be evaluated as additional hospitals are added to PHF.

CREDIT PROFILE

PFH, headquartered in Ontario, CA, was founded in 2006 by Prem Reddy who had previously founded PHSI. PHSI was founded in 2001 with the strategy of acquiring and turning around financially distressed hospitals. Since 2001, PHSI has grown to a nationwide system of 31 hospitals in 14 states with total operating revenues of $3.3 billion in fiscal 2015. Since PHSI donated PHF's first hospital in 2009, PHF has grown to 11 hospitals with total operating revenues of $476 million in fiscal 2015. Fiscal 2015 operations included seven hospitals, six of which were donated debt free from PHSI and the seventh hospital was acquired in 2013. PHSI donated an additional hospital to PHF on Dec. 31, 2015 and PHF subsequently acquired three additional hospitals in February 2016. Additionally, PHF is in the process of acquiring a twelfth hospital with an expected closing date in summer 2016 and an additional hospital is likely to be donated to PHF in fiscal 2016.

PHF and PHSI are separate legal entities and are governed by separate boards of directors with no overlapping members.

MANAGEMENT TEAM EXPERIENCE

PHF's senior management team has significant experience in hospital operations and with turning around financially distressed hospitals. Both PHF and PHSI are managed by the same senior management team through management services agreements with Prime Healthcare Management Inc. The combined entities currently operate 42 hospitals and have grown from 14 hospitals in 2011, primarily through acquisition of financially distressed hospitals while maintaining solid operating profitability. Fitch views the senior management team's experience favorably, particularly with their experience in acquiring and turning around financially distressed hospitals.

LOW DEBT BURDEN

PHF's light debt burden is primarily due to the majority of its hospitals being donated debt free from PHSI. PHF had approximately $85.9 million of total debt outstanding at Dec. 31, 2015. The debt portfolio is comprised of approximately $45 million of bonds issued on behalf of Knapp Medical Center which was acquired by PHF in 2013, an approximately $34.5 million line of credit draw and various capital leases both of which are classified by Fitch as long term debt. The outstanding Knapp Medical Center bonds are variable rate demand bonds supported by a letter of credit.

Fitch's analysis assumes that line of credit draws are amortized over 30 years with a fixed interest rate of 5%. Historical MADS is estimated to equal $5.1 million, equating to a light 1.1% of fiscal 2015 operating revenues. The light debt burden allows for solid MADS coverage despite modest operating profitability. MADS coverage by operating EBITDA equaled a strong 5.6x in fiscal 2015.

Subsequent to the completion of the four acquisitions in fiscal 2016, MADS is estimated to increase to $7.2 million. The increase is due to expected line of credit draws used to acquire the four hospitals. The revenue growth associated with the new hospitals mitigates the impact of the increased debt burden, with the increased MADS equal to 0.9% of pro forma fiscal 2015 operating revenue (including a hospital donated to PHF on Dec. 31, 2015 from PHSI, the three hospitals recently acquired in February 2016 and a fourth hospital expected to be acquired in summer 2016). However, the operating losses at the new hospitals in fiscal 2015 would have materially weakened coverage metrics.

Fitch expects that PHF's light debt burden will be maintained as it draws upon a $200 million line of credit expected to be entered into in May 2016. The line of credit draws are expected to be used to fund future hospital acquisitions and may be converted to permanent debt over time. The increased consolidated revenue base from the potential hospital acquisitions should mitigate the impact of the increased debt from the draws.

MODEST HISTORICAL PROFITABILITY

Historical operating profitability has been light with operating EBITDA margin averaging 6.3% since fiscal 2012 and equal to 6.0% in fiscal 2015, comparing unfavorably with Fitch's 'BBB' category median of 7.7%. Historical profitability has fluctuated somewhat, with operating EBITDA margin ranging from 5.2% to 8.2%, primarily due to the addition of new hospitals to PHF. PHF grew from three hospitals in fiscal 2012 to seven hospitals in fiscal 2015. Additionally, operating profitability was compressed in fiscal years 2014 and 2015 due to lumpiness in the receipt of California provider tax proceeds. PHF's light operating profitability is currently mitigated by PHF's light debt burden.

The pro forma impact of the new hospitals (including the hospital donated on Dec. 31, 2015, the three hospitals recently acquired in February 2016 and one hospital expected to be acquired in fiscal 2016) materially compresses operating profitability based on historical results. However, management is projecting operating EBITDA margin to increase to 8.0% in fiscal 2016 as PHF's operating improvement initiatives are implemented at the new hospitals. As previously noted, the management team has significant experience in turning around financially distressed hospitals. Fitch expects that consolidated operating profitability will remain at levels sufficient to provide cash flows to sustain coverage metrics consistent with the rating category.

STRONG LIQUIDITY RELATIVE TO DEBT

With $214.7 million in unrestricted cash and investments at December 31, 2015, PHF's liquidity metrics are strong relative to its low debt burden with 250% cash to debt and 42.2x cushion ratio at December 31, 2015, easily exceeding Fitch's 'BBB' category medians of 89.5% and 11.1x, respectively. Liquidity relative to operating expenses is solid with 174.2 days cash on hand, exceeding Fitch's 'BBB' category median of 161.5 days. As PHF draws upon the line of credit to acquire additional hospitals, liquidity metrics relative to debt could be compressed, however, management is projecting unrestricted liquidity to increase over the next five years. Additionally, given the current strength of PHF's liquidity relative to debt, related metrics could compress without impacting the rating.

DISCLOSURE

PHF is expected to covenant to provide annual disclosure within 150 days of each fiscal year end and quarterly disclosure within 60 days of each fiscal quarter end.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Nonprofit Hospitals and Health Systems Rating Criteria (pub. 09 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=866807

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1002240

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1002240

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1-312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Adam Kates
Director
+1-312-368-3180
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Emily Wong
Senior Director
+1-415-732-5620
or
Committee Chairperson
Jim LeBuhn
Senior Director
+1-312-368-2059
or
Media Relations:
Elizabeth Fogerty, New York, +1 212-908-0526
Email: elizabeth.fogerty@fitchratings.com