Tenet Healthcare Rises Despite Worrisome Trends

The hospital chain continues to have trouble collecting from managed care payers.
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Tenet

(THC) - Get Report

continued to struggle during the sector's healthiest season of the year.

The ailing hospital chain posted weak fundamentals and even missed the

updated earnings guidance it issued just last week. The company saw net revenue -- which was hit by soft admissions and weak managed care pricing -- slip 2.9% to $2.67 billion in the latest quarter. Special charges, mostly related to hospitals the company hopes to sell, sent first-quarter losses rocketing more than sixfold to $122 million. And a last-minute arbitration judgment, issued in favor of a managed care payer, forced the company to tack a penny onto its expected per-share loss.

Excluding special items, however, Tenet posted a first-quarter operating profit of 5 cents a share that was 2 cents better than the consensus estimate. During a conference call Tuesday with analysts, Tenet CEO Trevor Fetter pointed to the first-quarter results as "the first tangible evidence" that the company is making progress on its ambitious turnaround plan.

Tenet investors continued to gamble big on the company's ultimate recovery. Shares of the giant hospital chain surged 4% to $12.38 on Tuesday afternoon, setting a two-month high and extending a rally that heated up when the company preannounced quarterly results late last month.

Poor Condition

Still, several industry experts diagnosed the quarter as a poor one.

UBS analyst Kenneth Weakley, who first exposed Tenet's unsustainable growth strategy 18 months ago, quickly noted declines in revenue and cash flow. He also declared Tenet's cost controls -- celebrated Tuesday by the company itself -- as simply "OK" and "not yet indicative of stability." But he lists his primary concern as Tenet's potential loss of doctors who refer business to the company's hospitals.

Tenet is under intense government scrutiny for, among other things, paying possible kickbacks to its referring physicians. Despite market rumors to the contrary, however, Tenet said on Tuesday that it has suffered no meaningful deterioration in its relationship with doctors. Still, the company -- like others throughout the industry -- is losing some lucrative outpatient business to new doctor-owned facilities.

Peter Young, a business consultant who caters to the hospital industry, pointed out that Tenet weathered declines in both inpatient and outpatient business during the typically strong first quarter. Young also pounced on the $8 million arbitration charge that caused the company to miss its latest guidance.

"We still don't have guidance from the company on how many insurance company disputes exist, but the $8 million agreement is not likely the last," Young said. "Expect more quarters with settlement charges."

For its part, Tenet said that it tends to settle the vast majority of contract disputes before they ever reach arbitration. In the meantime, however, some 20% of the company's huge bad debt load is caused by unpaid bills from its managed care payers.

Tenet is currently struggling to mend managed care relationships that soured after its aggressive pricing strategies came to light more than a year ago.

"We strive to ensure that we are appropriately compensated for the services we provide, but third-party payers continue to ask us to accept lower rates of payment even in the face of rising medical costs," the company's latest quarterly report states. "We

also have disputes with a number of third-party payers over payment for past services."

For the first time in recent history, Tenet is generating less than half of its net revenue from managed care customers.

Fetter cautioned on Tuesday that Tenet's biggest obstacles -- weak pricing and volume growth -- will take some time to overcome. He also warned investors against reading too much into first-quarter results and stopped well short of updating guidance of break-even earnings and negative cash flow for the year.

No Surprises

Jeff Villwock, a health care analyst at Caymus Partners, found no big surprises -- or causes for celebration -- in the company's latest results.

"Maybe investors don't understand the hospital business very well," said Villwock, who has conducted research on behalf of the Tenet Shareholder Committee for years. "But this was seasonally the strongest quarter of the year ... it kind of makes you wonder what's going to happen in the third quarter."

In the meantime, Villwock views Tenet's first-quarter operating margins as weak. He also believes that the company is still "on track to lose over $500 million in cash this year."

Still, Villwock said that investors were probably relieved by Tuesday's in-line results. And even Fetter acknowledged that shareholders may now be defining good news as "the absence of bad news."

"It has been a while since we've had some good news to break to investors," Fetter confessed, when opening Tuesday's conference call.

Tenet was particularly pleased by cost efficiencies -- and an unexpected sequential drop in bad debt expense -- during the latest quarter. But Weakley, for one, needs more signs of progress before he can raise his $7 price target on Tenet's stock.

"Generally speaking, we need to see some form of stability within the operating performance of the company, coupled with some clarity on the legal risks," said Weakley, who has a reduce recommendation on Tenet's shares. "At this point, both of those are lacking."