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Tenet Default Raises Eyebrows

Some observers are wondering who's holding 30% of Tenet's long-term bonds -- and why.

Updated from 1:32 p.m.

Tenet Healthcare's

(THC) - Get Tenet Healthcare Corporation Report

latest accounting headache has an unusual twist.

The hospital chain's inability to file timely financial statements has left it in default on $140 million worth of bonds due in 2031. The company now must cure that default over the next 90 days or face possible repayment of those bonds and cross-defaults on others.

For its part, Tenet expects to satisfy that requirement by filing its second-quarter report before the Nov. 23 deadline. Even if the company succeeds, however, at least one Tenet critic finds it interesting that an investor has accumulated a 30% stake in the company's long-term bonds.

"In bankruptcy, all bonds are treated exactly the same regardless of maturity," explains Jeff Villwock, a Caymus Partners analyst who conducts research on behalf of the Tenet Shareholder Committee. "Whoever bought those bonds did not do it because they thought the bonds were going to mature at par in 2031. Clearly, this is a bankruptcy play."

Villwock says his committee -- which has long been critical of Tenet leadership -- began to intensively study possible bankruptcy scenarios about a year ago. He says he ultimately determined that investors looking to best position themselves for a Tenet bankruptcy would want to buy the 2031 bonds, which are cheapest because of their maturity date, and short the company's stock.

Villwock says that somebody has clearly done the first, at least, and now controls enough notes to enjoy a "blocking position" that would protect that investment in any bankruptcy negotiations. Meanwhile, he says, the spread between those bonds and more expensive shorter-term notes has already narrowed from 20 points to 9 points in less than a year.

Tenet said it never identifies debt or equity holders as a matter of policy. "Our filing clearly indicates we expect to file the second quarter 2005 10Q within the 90-day cure period," a spokesman said. "This would resolve the cause of the notice." As for the bankruptcy chatter, the spokesman said, "That sort of speculation is ludricrous." Indeed, Villwock himself sees no immediate threat.

"There's a good probability that Tenet will be able to cure the default, and this issue will go away," Villwock says. "However, I find it very, very interesting that somebody out there is clearly making a very large bet on bankruptcy here."

In typical fashion, Tenet's stock weathered the bad news fairly well. The shares slipped just 1.3% to $12.72 Friday after posting a 25% gain over the past year.

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Outside Help

Five weeks have now passed since Tenet first warned investors of a possible accounting problem at three of its California hospitals. Specifically, the company revealed that those hospitals may have recorded excessive "contractual allowances" -- or discounts for managed care companies -- in certain periods and then released the extra reserves in a manner that boosted results later on.

At the request of the

Securities and Exchange Commission

, Tenet launched a forensic investigation to determine whether those hospitals -- and possibly others -- had in fact improperly reported revenue in the past.

Peter Young, a business consultant at HealthCare Strategic Issues, finds it interesting that Tenet chose

Huron Consulting Group

(HURN) - Get Huron Consulting Group Inc. Report

to carry out that work. Young says that many accounting firms could have easily examined the reserves in question. However, he says that Huron offers far more than that.

"I would view Huron as an outside specialist that's working to address multiple issues," Young says. "With its depth of talent, this is really a restructuring company."

Moreover, Young has his doubts that Tenet will in fact be able to file its quarterly report and satisfy its bondholders. Rather, he believes the forensic investigation has actually widened to include more hospitals -- and become more time-consuming -- since it was first announced.

Meanwhile, Fulcrum analyst Sheryl Skolnick has already warned of a serious threat as well. As soon as Tenet announced the likely delay of its second-quarter report, Skolnick raised the possible -- if remote -- risk that the company could see its stock delisted.

"We believe that some signification portion of the shareholder base would no longer be able to own THC shares if the company were not in compliance with timely filing requirements," wrote Skolnick, who has a hold rating on the company's stock. "This is a very high-risk situation, and we remain concerned that current holders still do not grasp the scope or gravity of the fix that THC is in."