HCA Critics Take Aim at Buyback

Analysts wonder how the company will pay for its ambitious Dutch auction amid an industry downturn.
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is feeling more pain.

The company weathered multiple downgrades after announcing weak operational results and a controversial stock repurchase plan on Wednesday. At least four analysts have stopped recommending the stock, and both major ratings agencies now label the company's credit junk.

Fulcrum analyst Sheryl Skolnick understands why. Skolnick herself has a negative long-term outlook on the stock due to problems, she feels, that could prove difficult to cure. And HCA's planned Dutch auction, which provides a temporary floor beneath the share price, has clearly failed to soothe her.

HCA intends to finance the stock repurchases with $2.5 billion of debt -- further stretching the balance sheet -- at a time when the company's fundamentals are deteriorating.

"We view the repurchase funded on credit as very risky," said Skolnick, who has a neutral rating on the stock. "Promising future cash flows in an environment as volatile and uncertain as the one facing the industry today is subject to serious concern, in our opinion."

Skolnick compared HCA's plans to a doomed strategy carried out by


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. Tenet also started buying back its own stock when its business was deteriorating. The company finally stopped, however, because it could no longer spare the cash.

Gimme Credit bond analyst Carol Levenson is now coming down hard on HCA. She described HCA as a "serial offender" that has hurt bondholders before, ridiculing the company's claims that it is making "prudent" use of its resources.

In new financial documents, HCA "warns of reduced financial flexibility, the potential impact on liquidity, financing risk, a significantly higher debt service burden (and all that this implies), competitive disadvantages and increased economic vulnerability," wrote Levenson, who is steering investors clear of the "Bottom 10 List" name. "This doesn't seem to fit any definition of 'prudence' we've encountered."

Instead, some smell desperation.

"A company does not engage in this type of financial hijacking of the credit side for a quarter or two of problems," says Peter Young, a business consultant at HealthCare Strategic Issues. "This is a company facing protracted problems."

HCA has already lowered its guidance for both this year and next. The company's stock, which took a hit Wednesday despite news of the Dutch auction, was flat at $35.74 early Friday.

Lasting Injuries

HCA blamed one-time items -- including hurricane disruptions -- for most of its anticipated third-quarter miss. But Skolnick quickly noted that "deteriorating margins" caused nearly as much damage. And she expects the problems to last.

"I don't believe their numbers for next year," she said bluntly.

Skolnick is particularly troubled by a new weakness in HCA's managed care revenue. HCA pointed to "a shift in product mix to lower-paying plans" as part of the problem. In a phone call with


on Thursday, the company elaborated by saying that more patients are choosing health care plans that offer lower hospital reimbursements than the major insurers do.

Skolnick noted that HCA is about to report its lowest "revenue per equivalent admission" so far this year. At the same time, she pointed to the company's bad-debt expense as the highest in the industry.

Looking ahead, Skolnick worries that the new managed care trend could make matters even worse. She says the shift to "individual-based, lower-paying, higher-deductible plans" places a greater financial burden on patients who might bypass expensive procedures and therefore pressure hospital volumes. Moreover, she says, those who do seek treatment could face huge deductibles that cost them almost as much as having no insurance at all.

"As a result," she concluded, "collectibility continues to be an ongoing issue, thereby adding to bad-debt concerns."

Skolnick sees a potential threat to the industry as a whole. Moreover, she's "hard-pressed to see any catalyst" that will reverse the industry's path. She warns against counting on flu patients, hurt by the vaccine shortage, to boost short-term results. She says that most hospital flu cases are low-margin admissions involving "the very old and very young and those who don't pay." So she says a flu-based bet on hospital stocks is "exactly the wrong call."

Skolnick isn't banking on a lot of new business from baby boomers, either. She attributes the last industry surge to a sudden increase in high-intensity services -- "the old Tenet story" -- that probably won't happen again. She can't imagine any new procedure that would trigger a big jump in demand going forward. And she can't see how patients would necessarily pay for the treatment even if that happened.

"While some believe the demographic transition of the baby boomer will provide the demand for the model, we fail to see where the resources will come from to afford the treatment demand," Skolnick said. "As we have said in the past, 'starvation in the land of plenty' may be the story told by the hospital industry."

Skolnick calls hospital stocks "dead money at best" for the next year. Following HCA's latest report, she clearly sees more trouble ahead.

"Medicare will not be your friend," she warned. "Medicaid is not your friend. The uninsured is not your friend. And managed care has just gotten a lot more unfriendly. Why would you want to own" the stocks?