HMA Could Feel Tenet Backlash
Health Management Associates
(HMA)
is way past due for a checkup.
Granted, HMA's strong immune system has protected it from sectorwide ailments in the past. But the company isn't necessarily the picture of health anymore. Indeed, some critics suspect that HMA has been suffering for some time, and that its habit of swallowing hospitals -- almost like medicine -- could be masking its problems.
"The only way to tell for sure ... is for the company to stop acquiring hospitals and start operating them," Fulcrum analyst Sheryl Skolnick stated in a sell recommendation issued late last month.
Skolnick points to HMA's sliding cash flow -- down six of the last nine quarters -- as a symptom of "long-term trouble." And Kenneth Weakley, the UBS analyst who first exposed
Tenet's
(THC) - Get Report
fragile condition, offers a dark prognosis as well.
Like Skolnick, Weakley portrays HMA's cash-flow picture as "particularly worrisome." Yet Weakley also warns of a more serious threat, spreading since Tenet fell ill, that could trigger lasting complications for the company.
Weakley is convinced that Tenet's aggressive pricing strategy has left other hospital chains exposed to possible backlash. And he points to HMA, where pricing has served as a powerful growth hormone, as the most vulnerable of the lot.
Medical Records
In the spring of 2000, as Tenet revved up its prices -- and its profits -- ahead of a brewing proxy fight, then-HMA CEO William Schoen registered to sell 1 million shares of stock in his own hospital company.
As a local Florida banker, Schoen had rescued HMA from a near-death experience 17 years earlier. By the time he formally took over as CEO in 1986, the former beer executive -- who made a small fortune merging Schaefer with Stroh's -- had already settled on rural acquisitions as the perfect tonic for growth at HMA. He amputated the company's bleeding urban hospitals and began stitching together a network of small-town facilities, facing virtually no competition, in their place.
A decade later, Schoen's formula seemed like an outright miracle cure.
"About half the hospitals in the country are scared,"
The Wall Street Journal
stated in 1993. "The other half are broke. Then, there is Health Management Associates."
The Journal
pointed out that HMA had impressively grown operating profits -- for the 33rd quarter in a row -- at a time when the rest of the industry was ailing. And it listed a number of reasons for the company's success.
HMA had exercised perfect timing by snatching up rural hospitals at about half-price after Medicare tightened its rules when Schoen first arrived. Schoen ran a "tight ship," featuring a bare-bones corporate staff and young hospital managers who could make a name for themselves by hitting financial targets. The company also found innovative ways to improve patient satisfaction and cater to the "all-important senior citizen market."
Analysts had to hunt for a weak spot.
"If there's a downside, it would be that the company is something of a one-man show," one analyst told
The Wall Street Journal
, obviously referring to Schoen. "I'm not sure how healthy that is."
Nevertheless, the winning streak continued. Nourished on a steady diet of rural acquisitions, HMA blossomed into a Wall Street darling, growing profits by nearly 30% annually. But side effects from HMA's high-powered growth formula would eventually surface.
In 1998, the Center for Healthcare Industry Performance Studies offered a startling statistic to the trade publication
Hospitals and Health Networks
. After acquiring a rural hospital in 1996, the Center reported, HMA hiked its rates for the five most common procedures by 8.6% to 44.3% in a single year. On average, the Center stated, other hospitals increased the same rates by only 5%.
In response, HMA downplayed the increases -- saying that few parties pay full sticker price anyway -- and attributed the hospital's profit growth to stronger volumes instead of higher bills. But bigger headaches were brewing. By early 1999,
Modern Healthcare
would later reveal, HMA's savvy CEO had begun shifting daily management responsibilities to a fellow beer executive, current CEO Joseph Vumbacco. The following quarter, HMA actually found itself earning less than it had a year earlier. HMA's ultimate profit warning, sprung on an unsuspecting Wall Street in the summer of 1999, wiped out nearly 30% of the company's value in a single day.
Less than six months later, after the stock fully recovered, Schoen filed his paperwork to sell 1 million shares. After another eight months, Schoen officially passed the baton to Vumbacco in early 2001 and settled into the sole position of company chairman.
Early Diagnosis
Nearly two years passed before Weakley conducted the groundbreaking research that would expose Tenet and, eventually, cause him to fret over HMA as well.
After hearing a "chorus of concern" about hospital rate increases -- and questioning Tenet in particular -- Weakley pounced on a small, but important, clue in Tenet's October 2002 earnings report. The company's Medicare business, as a percentage of revenue, had jumped in the face of an industrywide decline.
"I had my team get all the Medicare information they could find," Weakley said. "Then one Friday, I looked down and saw the formula for outliers. The first element was gross charges. That was interesting."
Weakley's group soon honed in on a single data point -- Medicare outlier ratios -- that would explain most of Tenet's recent pretax profit growth. Tenet relied on the generous outlier payments, offered for treating especially sick patients, far more heavily than the industry itself. While others collected about 5% of their Medicare income from outliers, Tenet generated 23.5% of its Medicare revenue -- and, at some hospitals, far more -- from those particularly lucrative cases.
Weakley said he actually shivered at the evidence in front of him.
"I didn't know what to do," he told
TheStreet.com
last week. "This was real."
When questioned, Weakley said, Tenet first attributed the high outlier ratio to its patient case mix and -- when that backfired -- brushed him off completely. Weakley's reduce recommendation, issued a few days later, helped push Tenet into a downward spiral from which it has never recovered.
Meanwhile, Weakley continued to worry about other time bombs in the sector. With gross charges under scrutiny in the wake of Tenet's blowup, Weakley decided to launch an extensive quantitative analysis in an effort to identify other companies at risk. HMA immediately lit up on his radar screen.
"When the numbers start to get too far out of the norm, you have to start taking a look," explained Peter Young, a business consultant who counts hospitals among his clients. "The HMA numbers don't line up with the same-size competitor on the for-profit or the not-for-profit side, so they're suspect."
Between 1999 and 2001, Weakley found, price hikes at HMA's newly acquired hospitals doubled the company's average. Moreover, he said, prices at HMA's existing hospitals appeared to have been "higher than average for a long time."
Weakley issued a reduce recommendation, warning that HMA's pricing could shrivel under the spotlight and cut into earnings going forward. In a curious move, the company shot back by publicly attacking Weakley's study -- offering information it had denied the analyst earlier -- and even questioning his motives.
HMA again defended its pricing this week, when questioned by
TheStreet.com
. The company said that it "adjusts prices accordingly" at newly acquired hospitals that have "done a poor job of capturing charges" in the past. And it called its overall prices competitive based on the level of care it provides. It also downplayed the significance of gross charges in general.
To be fair, Weakley now concedes that HMA relies on gross charges for less revenue than he originally assumed. But he also says that revelation fails to comfort him.
"This doesn't mean there won't be scrutiny," he said. "This doesn't mean there won't be problems with acquisitions and media coverage. ... People are waking up to the pricing problem. I don't know if this
strategy is sustainable."
Second Opinion
Already, HMA has found itself tampering with its original formula for success.
In order to grow at its same rapid clip, Weakley said, HMA must acquire more -- or bigger -- hospitals in markets it can't always dominate. For example, the company just completed its largest acquisition ever, buying five hospitals from none other than Tenet, despite what Weakley describes as a "very rich price" and tougher opportunities for margin expansion.
Even so, the company declared that transaction a resounding success in its latest conference call. It also indicated that it suffered no more than a sniffle during a tough flu season that hammered some of its peers.
"Overall," CFO Robert Farnham declared, "another excellent quarter."
But Skolnick dissected the results herself and issued a dark second opinion. Same-hospital revenue among inpatients had crept up less than 1%. EBITDA-per-adjusted admission had actually fallen 3%. And a 14.5% surge in emergency room visits, hinting at lower-margin cases, was "
not
something to cheer about."
Still, HMA's cash flow -- down 15% in the latest quarter -- troubled Skolnick most.
"Even though consolidated EBITDA rose ... HMA did not convert this increase to cash," she stated. "So was this quarter's 20% earnings growth real?"
For its part, HMA attributed the drop in cash to delayed Medicare numbers -- required for billing and collections -- at the former Tenet hospitals. But Skolnick, noting similar drops in five previous quarters, pointed to a "clear trend" in cash flow erosion at the company.
"This looks to us like a classic acquisition-driven story in which the deterioration of the fundamentals in the same-store business is being hidden by accounting for the acquisitions," Skolnick wrote. "Despite management's enthusiasm on the conference call and their cogent explanation for a dramatic decline in cash flow ... we remain highly skeptical of these results."
But HMA stands behind its story.
"Acquisitions are not masking poor performance," HMA spokesman John Merriwether told
TheStreet.com
. "Same-hospital operations have been consistently solid for many years."
Nevertheless, some people appear to be worried about the company's future. Last month, a number of big HMA investors filed the paperwork to sell $575 million worth of convertible notes they had purchased less than six months earlier. And even before then, HMA insiders were selling big slugs of the company's stock. Schoen alone has carried out five multimillion-dollar option transactions over the past two years.
When questioned about the sales, Merriwether pointed out that HMA's current CEO has actually been increasing his stake in the company. He also insisted that Schoen hasn't been selling his personal HMA stock.
"The bulk of the proceeds from
Schoen's most recent option exercise were used to supplement an existing family charitable foundation," Merriwether said. "Mr. Schoen has not decreased his outright ownership of shares in years."
But Young, for one, smells trouble.
"It looks like some folks want to get off the train before the derailment," he said. "This is a pretty clear indication that a large group of
investors believe the company's prospects are not as good as management says."