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Tenet Drops as Cash Flow Plunges

The troubled hospital company's financial performance is even weaker than expected.

A big Medicare cut has left


(THC) - Get Tenet Healthcare Corporation Report

deeply wounded.

Stripped of big "outlier" checks from Medicare -- bonus payments that pumped up earnings in the past -- Tenet has seen its earnings power weaken considerably. And the damage, expected to be serious, is worse than first diagnosed.

The nation's second-largest hospital chain reported Thursday that profits plummeted to 40 cents a share in the third quarter, the first period fully hit by dwindling outlier payments. That's a 35% tumble from year-ago profits of 62 cents a share, and well short of the 53 cents analysts were generally expecting.

Tenet's stock took a quick hit, falling 5.7% to $14.20 a share, before climbing back above $15 later in the morning.

Tenet blamed much of the shortfall on a voluntary cut -- made mandatory by new Medicare rules -- in its billing for complicated procedures. The company toned down its aggressive outlier billing on Jan. 1, following accusations that it had been exploiting a Medicare loophole and even performing some of the high-margin medical procedures without reason.

Under more conservative policies, Tenet saw its quarterly outlier payments plummet to $40 million from $191 million a year earlier. Going forward, those outlier checks are expected to slow to a trickle, bringing in only $6 million a month because of the new Medicare guidelines. Tenet had been expecting at least $8 million a month -- a mere fraction of past payments -- based on the internal changes it adopted ahead of the official Medicare rules.

Tenet blamed the outlier changes for deep cuts in profit margins and a huge jump in malpractice expenses. Faced with massive litigation -- much of it stemming from dangerous outlier procedures -- Tenet hiked its third-quarter malpractice reserves from $50 million to $189 million. That added expense, coupled with outlier-related impairment charges, helped lead Tenet to an overall net loss of 12 cents a share for the quarter.

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Fulcrum analyst Sheryl Skolnick worries that the malpractice jumps may not be a one-time event, either.

"What this says to me is that they've got a problem where the cost of claims have gone up -- and gone up a lot," said Skolnick, who's bearish on virtually all hospital names. "If this is not a one-time item, and my guess is that it may not be, the

earnings hit is 11 cents a share."

Tenet is currently expecting to earn $1.34 to $1.65 a share this calendar year. The company last reported full-year earnings -- including hefty outlier profits -- of $2.17 a share.

It also enjoyed strong cash flow, a figure that's now starting to plummet. The company reported third-quarter cash flow of $327 million, down nearly one-third from a year ago. Free cash flow -- the money left after paying capital expenditures -- plummeted 68% to $98 million during the quarter.

Skolnick viewed Tenet's cash flow, apparently boosted by a tax refund, with particular alarm.

"That is not a good number," she said bluntly. "You can't get to

Tenet's full-year guidance at $98 million a quarter. It's half as much as it needs to be."

Tenet CEO Jeffrey Barbakow, who agreed to step down as chairman earlier this week, admitted Wednesday that the company faces challenges. But he remains optimistic about Tenet's long-term future.

"We are clearly in a transitional period, and we continue to address aggressively the challenges facing the company," Barbakow said in a prepared statement Wednesday. "Some of

our actions will impact our near-term performance but are necessary as we work to reposition the company and build a strong foundation for the future."