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Health Management Falls Ill on Downgrade

The stock drops 12% as an analyst questions the company's pricing plans.

Some of


(THC) - Get Tenet Healthcare Corporation Report

problems could prove contagious.

A Wall Street analyst warned on Monday that Tenet may have exposed another high-growth hospital chain, rural provider

Health Management Associates


, to potentially damaging scrutiny. Kenneth Weakley of UBS -- the firm that first exposed Tenet's unsustainable pricing strategy -- now suspects that HMA has been employing a similar growth formula.

Following a detailed analysis of the industry, Weakley concluded Monday that HMA has been relying on rising "gross charges" -- the list prices for hospital products and services -- for its rapid-fire growth. He warned that such charges, often used to calculate insurance reimbursements, could take a hit following intense examinations by government agencies.

"The rising focus on gross charges should add transparency to pricing strategies for the group, and those that have previously benefited from the lack of transparency could be at higher than average risk," Weakley wrote on Monday. "THC and HMA seem to stand out in terms of their relative gross charge levels."

Due to his concerns, Weakley downgraded HMA shares from neutral to reduce, and lowered his price target on the stock from $25 to $18. HMA immediately plummeted, falling 12% to $22.95, on the cautionary report.

Weakley's downgrade comes roughly 13 months after he first raised questions about Tenet's aggressive collection of Medicare "outlier" payments for complex procedures. Since then, Tenet has come under heavy fire for allegedly billing Medicare for unnecessary heart surgeries. The company remains the target of multiple investigations.

"For THC, the issues are well known," Weakley acknowledged. But "the focus and discussion on gross charges seems likely to continue and even accelerate going forward."

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HMA, Weakley predicted, could suffer the next big blow. Although far less aggressive than Tenet, he determined, HMA has maintained gross charge levels that are 30% to 40% higher than its for-profit peers. Moreover, he noted, HMA relies on those charges to negotiate most of its managed-care contracts.

Weakley concluded that HMA's strategy -- "key to its 'sector-leading' profit margins in the past -- may no longer work in the future."

"This strategy has been a sound business practice historically ... but with rising scrutiny, it may prove less successful going forward," he wrote. "Given that HMA's monopoly position in rural markets has allowed for such strong gross charge levels -- and given that it generates a fair amount of commercial revenues through contracts priced off of gross charges -- we believe that the increased transparency we refer to in this report may have the greatest impact on its financial outlook."

Under "normalized" gross charge levels, reflecting the industry average, Weakley calculates that HMA's 2004 profits would be $1 a share instead of the $1.36 Wall Street is currently expecting. He concluded that profit margins would still be strong "but certainly suggestive of a very different financial position" than the company's present one.

In contrast, Weakley sees little risk to some large urban players.

"The evidence from our work last year and updated and refined in today's note ... shows that, for


(HCA) - Get HCA Healthcare Inc Report


Universal Health

(UHS) - Get Universal Health Services, Inc. Class B Report

, such fears are unjustified," he wrote. "Neither has boosted gross charges dramatically. Nor has either maintained gross charge levels that warrant concern."

Weakley also tried to make clear that HMA -- while vulnerable -- is not another Tenet.

"We stress that the key concern with HMA is NOT that something untoward has occurred," he wrote, "but instead that the company's ability to sustain its strong pricing power of the past may be inhibited by the greater scrutiny of gross charges" by multiple government agencies.