HMA Hits the Wall

The once-beloved hospital chain is struggling.
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Health Management Associates

(HMA)

posted another weak quarter.

The rural hospital operator saw profit tumble 15% to $74 million during the latest period, as the company struggled to attract more patients who actually pay their bills. Excluding special items, earnings per share of 30 cents matched the consensus estimate.

Third-quarter revenue rose 10% to $994 million, with help from acquisitions, but still fell short of Wall Street's $1 billion target.

Some-hospital admissions and some-hospital adjusted admissions -- which include lucrative outpatient cases -- barely budged at all. Meanwhile, surgeries and emergency room visits actually fell in the latest period.

Uninsured cases continued to climb, however, pushing bad-debt expense ever higher. The company's bed-debt ratio totaled 9.5% of revenue in the recent period, up from 8.4% a year ago.

Days sales outstanding also rocketed, jumping from 66 to 74 days, due to delayed payments from the Centers for Medicare and Medicaid Services. Notably, HMA has yet to secure so-called "tie-in" notices for several hospitals the company has acquired.

Peter Young, a business consultant at Healthcare Strategic Issues, blames HMA itself for the problem.

"Most hospital purchases and Medicare paperwork occur far more timely, and in many instances a seamless transition occurs from day one," Young said. "The continued problem HMA has in this area is an apparent lack of post-purchase integration regulatory skills."

On a bright note, the company did collect higher rates from patients who do pay their bills. Revenue per adjusted admission rose 4.6% during the third quarter, thanks to price increases.

Still, pretax profit margins continued to deteriorate, falling from 20.9% last year to 20% in the latest period.

"The business metrics are all moving in the wrong direction," Young declared. "The press release says it all."

Warning Signs

Of course, HMA investors had reason to expect fresh pain.

Just last week, both

Triad

(TRI) - Get Report

and

HCA

(HCA) - Get Report

reported big third-quarter misses. While Triad faces some company-specific challenges, the results from HCA -- as the bellwether of the group -- seemed to spell trouble for the industry as a whole.

"HCA's pre-announcement this morning darkens the cloud over the hospital group," noted Morgan Stanley analyst Christine Arnold. "The results are consistent with our industry thesis. Bad debts will continue to rise. Volumes (particularly commercial) remain weak. And competition shows little sign of abating."

The report, she added, is "not an auspicious opening to

the 3Q06 earnings season."

HCA suddenly announced its results on the same day that Arnold happened to initiate coverage of HMA. Arnold has an equal-weight rating on HMA's stock, although her call looks optimistic to some.

For starters, Arnold portrays HMA's arrangements with physicians as "promising." She notes that HMA now relies on company-employed physicians for some 17% of its admissions, up from 12% just one year ago. She believes this shift will boost the company's top-line results "reasonably quickly" and could bring bottom-line payoffs a year or two down the road.

But even Arnold sees risks inherent in this strategy. Notably, HMA's rising labor costs -- boosted by large physician paychecks -- could hurt the company's margins if admissions remain under pressure.

Still, HMA has reached out to physicians in other ways as well. Arnold cites joint-venture arrangements as an example.

Yet some of those efforts have already fallen flat. Just days ago, in fact, a Pennsylvania newspaper reported that Brad Nurkin -- CEO of Lancaster Regional Medical Center -- would be leaving after a "bumpy tenure" at the HMA-owned facility.

"During Nurkin's leadership, the hospital ... launched a failed attempt to get local physicians to buy into a hospital-doctor partnership," the

Lancaster New Era

reported on Saturday. "And the hospital went through a transition in its cardiac program. Its longtime open-heart surgeon left the hospital in May and, shortly afterward, two groups of cardiologists announced they would no longer see patients at Regional" either.

To be fair, the newspaper reported that Nurkin also oversaw $2.2 million worth of improvements during his tenure at the facility. In addition, it noted that the hospital has restored much of its cardiac program.

Meanwhile, it revealed, Nurkin will soon relocate to another HMA hospital with fewer beds -- and far fewer doctors -- than the one he currently runs.

Mixed Prognosis

Arnold sees opportunities across the HMA system. Specifically, she believes that many HMA hospitals could stand to raise their prices.

She says that HMA's commercial prices have started lagging behind those of the company's peers. Thus, she says, HMA could be negotiating price hikes on managed care contracts representing some 30% of the company's annual revenue.

Arnold's theory contrasts sharply with claims made by HMA critics, who insist that the company regularly jacks up its prices far more than it should.

Her view on acquisitions stands out as well. She welcomes acquisitions as "the quickest way to generate volume growth" and hopes to see the company start buying hospitals again next year.

"As we see it, the good news is that there are decent properties to buy," wrote Arnold, whose firm has a financial position in HMA's debt. "Over time, we expect the company to shift its portfolio toward hospitals in larger, more affluent markets with higher acuity (and better pricing). ... The trade-off is that these markets are typically more competitive, with multiple hospitals and physician-owned ventures."

HMA once shopped primarily for bargain-priced hospitals that monopolized their rural markets. In recent years, however, HMA has strayed from the proven strategy that made the company such a big hit on Wall Street.

William Schoen, HMA's current chairman and former CEO, won credit for much of that past success. These days, however, Schoen hasn't shown a whole lot of faith in the company he helped build.

Rather, like clockwork, Schoen regularly sells huge chunks of HMA stock every year. He has pocketed more than $10 million through options transactions in the past three months alone.

Sheryl Skolnick, senior vice president of CRT Capital, recommends that investors follow Schoen's lead. Indeed, she has long questioned why investors still hold on to HMA's once-prized stock at all.

"We view HMA as a classic consolidation play that hit a brick wall and can no longer acquire its way out of its problems," Skolnick wrote following a profit warning from the company several months ago. "In our more than 18 years of research experience, we have seen this sad story often enough. But never have we seen such a loyal investor base clinging to its belief in the quality of HMA's assets and the legend of what HMA once was."