OKLAHOMA CITY -- Right now, hunting for a hospital company with a healthy balance sheet -- a key source of comfort in today's risky credit environment -- can try investors' patience.
Community Health Systems
, while still popular with industry analysts, carries a painful debt load following a huge acquisition that transformed the company into the nation's largest publicly traded hospital chain. HCA, which formerly held that title, has even more debt after going private in a big leveraged buyout. Ailing
has started looking like an outright bankruptcy candidate to some.
Rural hospital operators, long considered attractive because of their ability to monopolize their markets, have grown considerably weaker as well. In a move questioned by many,
Health Management Associates
recently sacrificed its strong balance sheet to borrow huge sums for a special dividend.
has been paying dearly for some perceived missteps of its own, particularly an unpopular acquisition.
Universal Health Services
, which stands out as a somewhat safe bet for risk-adverse investors, has its issues. Universal has a diversified portfolio that includes behavioral care facilities -- which are largely immune to bad debts from the uninsured -- in addition to traditional acute-care hospitals. Moreover, the company boasts the strongest balance sheet in the group. Universal is, therefore, in position to capitalize on weak market conditions by purchasing hospitals on the cheap.
But management, controlling most of the company's voting stock, calls all the shots. And with those executives eager to keep running the show, they seem unlikely to consider a buyout even if ordinary investors would welcome the handsome returns that such a transaction could bring.
Thus, some experts see few compelling investments in the entire group right now -- particularly given that the credit crunch sweeping U.S. markets has sharply cooled the once-scorching private equity buyout business.
"LBO hopes could cool, removing support in the face of muted volumes and turbulent bad-debt trends," Morgan Stanley analyst Christine Arnold warned last month. Ultimately, "given the industry backdrop characterized by slowing commercial volumes ... coupled with a rising number of uninsured, we believe that the hospital sector will be challenged to produce returns that exceed the overall market."
Arnold has an in-line rating on the hospital group as a whole. Her firm owns stock in both HMA and LifePoint. It also has business ties to several players in the sector.
In today's brutal hospital environment, hurt by weak volumes and rising debts from the uninsured, even a standout such as Community can start to look vulnerable -- especially after pursuing its most aggressive expansion in history.
"Community's management team has compiled a solid track record, but the company has encountered the same issues as its peers," Cowen analyst Kemp Dolliver reminded investors earlier this month. "We are concerned that the difficult industry backdrop (mainly bad debt) could overwhelm a significant portion of the long-term benefits" from the company's recent acquisition.
Thus, Dolliver added, "we remain neutral on the shares tied to strong industry headwinds and integration risk."
For HCA, paying off a huge debt load -- without the added burden of pulling off a big acquisition -- has proven challenge enough. After its record-setting $33 billion LBO, experts note, HCA has seen its free cash flow dwindle to less than 1% of the total debt it now carries on its balance sheet. With no industry recovery in sight, some wonder just how much time -- and how many asset sales -- it will take for the company to regain its financial strength.
Gimme Credit analyst Vicki Bryan notes that HCA's debt exceeds the entire budget for the company's home state of Tennessee in the meantime.
"To get leverage down
to acceptable targets, we estimate the company would need to sell 33% of its total portfolio," Bryan stressed last month. But "it's more likely that HCA slowly sells off a few hospitals, generates a little cash flow and pays down a little bank debt each year."
"It could be a long wait. ... The HCA transaction may have worked for the dealmakers, but even Sea Biscuit could lose a race if he carried too much weight."
Meanwhile, HMA has gotten itself into a tough fix without a big merger or LBO. In a move viewed as desperate by some, the former Wall Street darling borrowed billions to pay a generous one-time dividend to investors who were growing inpatient for returns. But the company's operational performance has continued to deteriorate in the meantime.
Indeed, only after HMA tapped accomplished industry veteran Burke Whitman to become its new CEO did some doubters start to feel fresh hope for the company.
"It is clear from Burke's commentary that things had gotten truly bad at HMA," JPMorgan analyst Andreas Dirnagl wrote after the company's devastating second-quarter update. But "we believe that for the first time in a number of years HMA could be headed on a path to improvement rather than further deterioration."
Still, even Dirnagl needs more proof. He is therefore sticking with his neutral rating on HMA until the company at least starts showing some early signs of progress. His firm has investment banking ties to the company.
Recently, HMA has delivered stunning disappointments. Even after fellow rural hospital operator LifePoint posted a big second-quarter miss, some -- such as Stephens analyst Whit Mayo -- assumed that HMA would fare OK. Instead, HMA followed up with an even worse second-quarter update of its own.
Mayo expressed his optimism about HMA when issuing an upgrade of Universal late last month. While his call on HMA proved wrong, his positive outlook on Universal -- given the company's unique diversification and balance-sheet strength -- is shared by other analysts in the group.
Indeed, Leerink Swann analyst Ann Hynes reiterated her own outperform rating on Universal the same day that Mayo published his upbeat report on the company. Hynes likes Universal's financial flexibility in particular.
"UHS hinted the acute-care acquisition market could become more attractive and anticipates several not-for-profits' assets will be for sale due to the deteriorating credit environment," Hynes noted. "Given that UHS's for-profit peers recently levered up ... we believe UHS has greater financial flexibility to take advantage of the potential acquisitions."
"Our 2007-2009E does not include any unannounced acquisitions," she added, "which could add upside to our estimates."
But Dirnagl, for one, feels more cautious. He is therefore maintaining his neutral stand on Universal's stock right now.
"We do note that UHS has a highly unlevered capital structure and a strong core portfolio of behavioral facilities that tend to provide some earnings support during operationally challenging times," acknowledged Dirnagl, whose firm has investment banking ties to the company. "However, given 2Q07 results impacted by the fact that hospital industry fundamentals continue to have no clear pattern for sustained improvement, we think that UHS is only appropriate for those investors with a long-term horizon."