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Heavy Debt Could Sicken HMA

Melissa Davis

OKLAHOMA CITY -- Health Management Associates (HMA Quote - Cramer on HMA - Stock Picks) better hope it sells some hospitals soon.

The rural hospital chain needs $575 million -- more than four times what it has in the bank -- to satisfy a payment to its debt holders this summer. The company has said it hopes to make up the difference by raising up to $400 million through asset sales, but has announced no deals so far.

Because hospital sales require time, and HMA has little to spare, some analysts have started bracing for the worst. They fear that the company could be forced to renegotiate its debt under terms that jack up its interest costs and seriously dilute its stock. If all else fails, they foresee an outright breakup of the company.

Sheryl Skolnick, senior vice president of CRT Capital Group, assumes that HMA will survive. Still, she has gone ahead and calculated HMA's likely break-up value, based on the financial performance of each of its hospitals, just in case.

Sold in pieces, she estimates, HMA would be worth just $1.12 a share. Right now, the company boasts a market value that's around five times that amount.

"Even we -- who have been so focused on the deterioration of profitability and so negative on the story for so long -- didn't realize just how much revenue growth and valuation based on revenues had deteriorated," Skolnick wrote earlier this week. "And if we didn't realize just how low the break-up value could be, we suspect that investors haven't figured that out yet, either."

Ultimately, she added, "continuing to assume that HMA has 'high-quality' assets that the Street doesn't have to worry about could be a very costly mistake."

Skolnick has a "fair value" rating on HMA's stock. Her firm makes a market in the company's securities.

Future Options

Skolnick still believes that HMA could sell some hospitals. She worries, however, that the company could fetch lower prices than it expects. And she warns against a fire sale.

"If HMA does not sell the assets at a high enough multiple, then it could trip its coverage covenants and trigger a technical default," she said. "The impact on the equity holders is quite obvious (lower earnings per share, cash flow), and we believe this is the one scenario that short sellers are most focused on as a result."

Personally, Skolnick doubts that HMA will choose to sell its hospitals on the cheap. She believes that the company will renegotiate its debt, if necessary, instead.

Still, the share dilution from such a move could be substantial. By Skolnick's calculations, HMA's share count could increase by a whopping 36%.

"Equity holders may not fully understand the potentially dilutive impact of even the best-case scenarios," she warns.

Of course, HMA hopes to sell a few hospitals instead. Indeed, just last month, the company suggested that it could be announcing a transaction by the end of this quarter. With negotiations reaching an advanced stage, it stressed, "it is certainly much more than a wish" at this point.

Nevertheless, Gimme Credit analyst Vicki Bryan suspects that HMA could come up short in the end. She wonders if HMA can really generate $400 million from asset sales. Even if HMA succeeds, she suggests, the company cannot spend all of that money on its looming debt payment.

While HMA hopes to use the funds to cover a put option, Bryan notes, the company's credit agreement dictates that it apply such proceeds to its $2.7 billion term loan instead.

Clearly, bearish investors foresee trouble ahead. In recent months, they have sold millions of shares of HMA's stock short in anticipation of a decline.

The stock, which closed at $5.56 on Wednesday, hovers near the bottom of its wide 52-week range.

Plan B

This week, HMA reportedly mentioned a new option. Under this plan, HMA would pay off half of its upcoming bill and then refinance the rest.

But Skolnick, for one, wonders how HMA will come up with the cash.

"The news thus far doesn't resolve a critical question," she stressed in a note on Tuesday. "Are the asset sales happening? If not, then the stock goes down SOON."

Without proceeds from asset sales, HMA would have to make due with its available cash and credit line. All told, the company has about $125 million in cash and $500 million in credit at its disposal.

However, experts say, HMA can use only a portion of that credit to cover the put option. Moreover, they add, the company would probably think twice about exhausting all of its resources even if it could.

"We hardly expect HMA to use all of the credit available on its revolver, so that means it could issue a sizable chunk of additional debt," Bryan wrote on Monday. "The incremental interest cost could put a serious dent in already weak cash flow ... Given our assumptions for weaker cash flow, higher debt costs and higher leverage, we continue to believe risk is increasing" at the company.

Bryan predicts that HMA's bonds will continue to lose value as a result.

Although Skolnick stops short of telling investors to sell the shares, due to her new faith in company management, she does urge them to pay attention.

"While we think HMA has lots of options that would prevent a really dire outcome, life has a funny way of taking unexpected and sharp turns," she observed this week. Ultimately, "being prepared is never a bad thing."