NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB/RR2' rating to CHS/Community Health System Inc.'s (CHS) $4.5 billion senior secured bank term loans G and H. Fitch expects that the company will apply the proceeds of the proposed term loans to refinance the existing term loan D due 2021. The Rating Outlook is Negative. The ratings apply to $17.0 billion of debt outstanding at March 31, 2015. A full list of ratings follows at the end of this release.
KEY RATING DRIVERS
Slow Deleveraging Post HMA: In 2014, Community Health Systems, Inc. (CHS) acquired rival hospital operator Health Management Associates (HMA) in a deal that added about $7 billion of debt to CHS's capital structure. Since the close of the transaction, growth in EBITDA has been hampered by some operational issues at the HMA hospitals and ongoing government investigations and lawsuits. This has delayed the pace of deleveraging; total debt-to-EBITDA is about 5.8x versus 5.2x prior to the acquisition.
Solid Strategic Rationale: The acquisition had a sound strategic basis because it enhanced the geographic scope of CHS's business while adding considerable scale. Fitch believes operational issues at the HMA hospitals were in part the result of HMA management distraction in the months leading up to the acquisition, and expects CHS to make improvements in areas like physician recruitment, which should improve organic growth and expand margins at the HMA facilities. Early signs of progress in these areas were evident in the company's Q1'15 operating results, which showed positive organic revenue growth on a same store basis including the HMA facilities and expansion of the operating EBITDA margin versus Q1'14.
Recently Improving Volume Trend: Prior to the HMA acquisition and early in the integration process, CHS's patient volume trends lagged industry peers and weighed on top-line growth and margins. Although a performance gap remains relative to peers in Q1'15 volume growth, CHS has made progress in this area, posting an improvement in volumes along with the rest of the for-profit hospital industry beginning in the second half of 2014. The economic recovery taking hold in more markets, investments in higher-growth service lines and expansion of health insurance under the Affordable Care Act (ACA) are supporting better growth despite ongoing secular headwinds.
Progress in Resolution of Legal Issues: CHS has been dealing with government investigations and lawsuits related to the issue of short-stay hospital admissions. CHS made progress in resolving the legal issues facing the legacy CHS hospitals during 2014, which did not involve financial fines significant enough to threaten financial flexibility or require major operational changes that would influence future revenue and EBITDA growth.
Liquidity Profile: CHS' liquidity profile is an important factor supporting the 'B+' IDR. The company has adequate cushion under the bank facility financial maintenance covenants, and cash from operations is fairly robust and is expected to be stable. At March 31, 2015, sources of liquidity included cash on hand of $222 million, LTM FCF of $563 million and availability on the revolving credit facilities of $932 million. Fitch projects that the company will maintain a 3% FCF margin, with FCF generation of about $600 million annually. While FCF could support debt repayment, Fitch expects most deleveraging to result from expansion of EBITDA, with the company instead prioritizing acquisitions as a use of cash.
Debt Maturities are Manageable: Near-term debt maturities are not a concern. Following the recent refinancing of the term loan series E, the next large maturity does not occur until 2018. Proceeds of the proposed term loan series G and H will be used to refinance the existing $4.5 billion term loan series D due 2021.
Maintenance of the 'B+' Issuer Default Rating (IDR) considers CHS maintaining total debt to EBITDA below 6.0x during 2015. Fitch thinks maintaining leverage at this level is achievable based on its forecast for CHS's 2015 EBITDA, and assuming only a small amount of debt paydown through amortization of the bank term loans. A sustained trend of positive organic revenue growth as seen in Q1'15, and maintenance of an operating EBITDA margin of at least 14%, would also support a revision of the Rating Outlook to Stable later in 2015.
A downgrade could result from leverage above 6.0x and an FCF margin below 2%. Risks to the operating outlook include the inability to achieve projected cost synergies and implement operational improvements at the HMA hospitals, lack of progress towards resolution of HMA's legal issues, and a reversal of the improving trends in patient volumes. In particular, a return to negative growth in CHS's organic adjusted admissions during 2015 would be concerning.
--Sustained positive organic growth in adjusted patient admissions, although the rate of growth is likely to taper later in 2015 due to more difficult year-over-year comparisons and a plateauing of the benefits of the ACA and improving economy
--Modest EBITDA margin compression in late 2015 - 2016, partly resulting from negative operating leverage as volume growth rates normalize and pricing trends remain stable, as well as integration of lower margin acquired hospitals, although Fitch expects an EBITDA margin of at least 14%
--EBITDA of $2.9 billion and FCF of $600 million in 2015 with capital expenditures of about $1.1 billion
--The majority of FCF will be directed towards acquisitions, with debt levels dropping only slightly from required principal payments on the bank term loans, resulting in gross debt/EBITDA declining to 5.5x through the forecast period.
DEBT ISSUE RATINGS
Fitch currently rates CHS as follows:
Community Health Systems, Inc.:
CHS/Community Health Systems, Inc.:
--Senior secured credit facility 'BB/RR2';
--Senior secured notes 'BB/RR2';
--Senior unsecured notes 'B+/RR4';
The Rating Outlook is Negative.
Total debt of approximately $17 billion includes $7.2 billion of first-lien secured bank debt, $2.6 billion of first-lien secured notes, $6.2 billion of senior unsecured notes, and $623 million outstanding under a $700 million capacity accounts receivables facility. CHS's bank debt includes approximately $7.1 billion in term loans maturing through January 2021 and a $1 billion capacity revolving credit facility.
The 'BB/RR2' rating for CHS's secured debt (which includes the bank term loans, revolver and senior secured notes) reflects Fitch's expectations for 83% recovery under a hypothetical bankruptcy scenario. The 'B+/RR4' rating on CHS's $6.2 billion senior unsecured notes rating reflects Fitch's expectations for principal recovery of 49%.
The Recovery Ratings (RR) reflect Fitch's expectation that the enterprise value (EV) of CHS will be maximized in a restructuring scenario (going concern), rather than a liquidation. In estimating its going concern EV for CHS, Fitch assumes a 35% discount to LTM EBITDA of $2.9 billion for CHS, resulting in a post-default cash flow estimate of $1.9 billion.
The magnitude of the discount to current cash flow is fairly substantial in this instance, given that the company is well removed from potential default, as reflected in the 'B+' IDR.
Fitch's post-default cash flow estimate for companies in the hospital sector mainly considers the structure of the industry. Hospital providers are highly exposed to potential cuts in Medicare and Medicaid payments since these companies can be considered price takers with respect to the 30% - 40% of revenues derived from patients with government-sponsored health insurance. Furthermore, cuts in government payment rates or unfavorable changes in the reimbursement environment (i.e. higher scrutiny of short-stay hospital admissions), will invariably influence payments from commercial health insurers, augmenting the impact on cash flow. Fitch then applies a 7.0x multiple to CHS's post-default EBITDA estimate of $1.9 billion, resulting in a going concern EV of $13.4 billion. The 7.0x multiple is based on observation of both recent transactions/takeout and public market multiples in the healthcare industry.
Fitch applies a waterfall analysis to the going concern EV, which is $12 billion net of a standard assumption of 10% for administrative claims, based on the relative claims of the debt in the capital structure. At Dec. 31, 2014, about 60% of consolidated total asset value resides in the guarantor group, which is used as an estimate for collateral value, with Fitch assuming that 60% of the going concern EV, or $7.2 billion, is recovered by first-lien secured holders, leaving $4.8 billion of non-collateral value to be distributed to unsecured claimants. Based on $10.8 billion of total secured claims (which includes the bank term loans, revolver and senior secured notes), the resulting first-lien secured deficiency claim of $3.6 billion is added to $6.2 billion of senior unsecured claims, resulting in $9.8 billion of total unsecured claims.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'High-Yield Healthcare Checkup' (April 30, 2015);
--'Hospitals Credit Diagnosis: Operating Performance Strength to Persist in Early 2015' (April 14, 2015);
--'For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices' (Jan. 7, 2015);
--'U.S. Leveraged Finance Spotlight Series: HCA Holdings, Inc.' (Dec. 9, 2014);
--'2015 Outlook: U.S. Healthcare' (Dec. 4, 2014);
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies
Hospitals' Credit Diagnosis (Operating Performance Strength to Persist in Early 2015)
For-Profit Hospital Insights (Fitch￢ﾀﾙs Annual Review of Bad Debt Accounting Policies and Practices)
U.S. Leveraged Finance Spotlight Series - HCA Holdings, Inc.
2015 Outlook: U.S. Healthcare (The Value Debate Intensifies While Aggressive M&A Continues)
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage