Taking Sides on Tenet

Trading surges as investors wager on the hospital chain's survival.
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OKLAHOMA CITY -- Betting on the future of Tenet (THC) - Get Report, an ailing hospital chain five years into an elusive turnaround, has suddenly become a popular Wall Street pastime.

While the stock has lost half its value since this time last year, trading volume in Tenet stock has shot through the roof. The stock traded, on average, more than 16 million shares a day over the past month -- more than tripling its year-ago daily activity level.

Even excluding the frenetic trading at the end of August -- when 74 million shares changed hands after an analyst issued a report predicting possible bankruptcy for the company -- Tenet's average daily share volume has jumped to 13.5 million shares from 4.6 million in the comparable year-ago period.

"Passions run deep," explains CRT Capital analyst Sheryl Skolnick, a rare Tenet bull better known for taking contrarian bearish positions on companies instead. She contends that "the Street view of the Tenet portfolio appears to be too focused on the negatives and not focused enough on the positives and is valuing the company accordingly."

But Skolnick was urging investors to buy Tenet's stock at twice its recent price of $3.25 a share. Meanwhile, a celebrated health care analyst -- whose groundbreaking research laid bare some Medicare pricing games played by Tenet's previous management, leading to the company's unraveling -- has predicted a dire turn for the company.

When initiating coverage of Tenet for Credit Suisse late last month, Kenneth Weakley valued the company at just $2 a share and -- warning of a possible Chapter 11 filing three years down the road -- suggested that the stock could become worthless in the end.

Tenet insists that it has ample resources to fund its operations, and it points to recent insider stock purchases as proof of management's faith in the company. But outsiders clearly have misgivings. Hotchkis & Wiley Capital Management -- a fund holding 61 million shares of Tenet's stock at the time of Weakley's report -- has liquidated its entire position in the company.

Tricky Math

In her latest attempt to value Tenet, Skolnick relied on official cost report data for the company's hospitals. That data, based on prior-year results, can provide strong clues about future revenue but -- due to volatile expense levels -- offers less insight about all-important earnings before interest, taxes, depreciation and amortization.

Nevertheless, working with what she had, Skolnick estimated future EBITDA at Tenet's hospitals and the market values of their beds. In the end, she came up with a range starting around $2 a share -- with beds valued at less than those sold in bankruptcy -- and rising above $6.50 a share. Looking further ahead, if things go well, she feels that the stock could ultimately approach $9 two years down the road.

"Even using our estimates for what should be one of THC's worst years in terms of revenue and EBITDA performance (or at least close to its worst year), there likely is more protection for the shareholders than the current stock price and other analysts' work suggest," Skolnick says. "Under all but the worst-case scenario, the hospital-level valuation analysis suggests that the Street is undervaluing THC's equity."

But Tenet critics see potential flaws in Skolnick's formula. For starters, they say, Skolnick has included too little debt and too much cash in her equation. Specifically, they say, she should at least be using year-end debt and cash projections -- with the latter metric expected to deteriorate significantly -- when determining the future value of the company. Based on this more conservative approach, they add, Tenet's value barely tops $1 a share.

"There is a break somewhere in her model," says one short-seller. Regardless, "I think she is being very optimistic about the turnaround."

Quality Control

For her part, Skolnick feels that critics focus too much on Tenet's financial metrics -- and too little on the steps being taken to improve them -- when evaluating the company's chances for survival. Skolnick herself takes plenty of comfort in Tenet's widely publicized "commitment to quality."

In the past, Skolnick acknowledges, Tenet had a reputation for charging high prices and providing poor health care services. But these days, she says, the company charges "reasonable prices and provides really, really, really high-quality care."

Under its new strategy, Tenet has seen insurers stop shunning the company's hospitals and start embracing them instead. Unfortunately, the executive perhaps most responsible for that transformation -- Chief Medical Officer Jennifer Daley -- has announced plans to leave Tenet this month for a job in a city where her family still lives.

Skolnick says that she regrets, but understands, Daley's decision. Still, Skolnick feels that Daley has already "put the revolution in place" and will leave strong followers of that movement behind.

"It's a shame Wall Street hasn't appreciated what she has done," Skolnick adds. "If volume and cash flow were up, they would get it.

But I think that the she is, in large part, responsible for the saving of this company."

Meanwhile, Skolnick continues to hold out hope that Tenet will ultimately survive.

"We're all getting kind of tired of waiting," she admits. "At some point, I think that the company has to put up or shut up," or investors will give up.

However, she adds, "I'm not there yet."