Tenet Stuck in Waiting Room

Investors will seek out hopeful signs in Tuesday's earnings.
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Analysts hold mixed views on just how fragile

Tenet

(THC) - Get Report

really is.

Granted, they all see a sick hospital company facing a long road to recovery. But they differ on whether investors should continue to hold out hope for the company or finally pull the plug and move on.

Tenet's dismal third-quarter results, previewed last week, posed a major test. The company's formal earnings report is due out Tuesday.

In the meantime, CRT Capital analyst Sheryl Skolnick has decided to stick with her buy recommendation on Tenet's stock and give the company another chance. But Deutsche Bank analyst Darren Lehrich recently downgraded Tenet to sell -- even after a big plunge in the stock -- and warned of further pain ahead.

"We believe THC shares will be pushed into a more volatile trading range that could lead to significant downside risk," Lehrich wrote last week. Meanwhile, "we expect the company's 3Q earnings report on Nov. 7 to underscore a more cautious view of the near/mid-term."

Tenet's stock, which fetched $7.42 at the time of Lehrich's report, slipped a penny to $6.83 on Monday. Lehrich has a $5 price target on the shares. His firm owns at least 1% of the shares itself.

In contrast, Skolnick sees a possible bargain for investors who can stomach the risk.

"One quarter does not a turnaround make or break," Skolnick insisted in a research note on Wednesday. Her firm doesn't own the stock. "Our thesis is a two-year view -- not a one-quarter view -- and we were pretty clear that we did not expect THC's performance to take off like a shot along an 'up-and-to-the right' trajectory. ... Thus, at the current share price and in the absence of more definitive good or bad news, we retain our buy rating and our $9.50 two-year share-price target" on the company's stock.

Meanwhile, Skolnick has studied Tenet's preannouncement in an effort to determine how the company's performance could have taken such a big turn for the worse.

Skolnick began by stating the obvious: Rising bad debts from the uninsured hurt the company's results a lot. So did weak volumes, with same-hospital admissions falling 3.3% from a year ago and lucrative managed care admissions falling nearly twice as much.

Skolnick believes that Tenet, like the industry itself, has little control over uninsured patients who do not pay their bills. However, she notes, Tenet has deliberately reached out to the so called splitter physicians -- who often refer their patients elsewhere -- in an effort to boost admissions of insured patients who do pick up their tabs.

That strategy seemed to falter in the latest quarter, with managed care admissions falling so hard. But Skolnick offers a different take. Indeed, based on absolute numbers rather than percentages, she estimates that managed care admissions actually dropped less in the third quarter than they did in the second. Thus, she sees some stability.

"Adjusted for seasonality, the decline in managed care admits is relatively constant," Skolnick wrote. "That suggests that, at worst, THC only lost a modest amount of market share in 3Q06 relative to its lost share for all of 2006. As some of this decline is likely related to the closure of units under the 'Targeted Growth Initiative,' THC intended to lose at least some of this share as it was unprofitable."

Skolnick offered an explanation for the company's poor pricing results as well.

Actually, "THC made progress both sequentially and year over year in commercial managed care revenue per admission," she noted. "If (our) math is right, then the deterioration in this key unit revenue growth rate is explained by a tough comp ... So the trend of pricing itself -- not of the rate of growth -- at least didn't deteriorate."

Still, she acknowledged, Tenet's volume losses overwhelmed the company's pricing gains and caused profits to collapse in the end.

Skolnick still has plenty of questions for management.

Most importantly, she wants to know if Tenet lost ground with the 1,300 splitter physicians who helped boost admissions last time around. If so, she worries that Tenet has lost those physicians for good and jeopardized the company's entire turnaround effort in the process. Thus, she hopes that the company's own "Targeted Growth Initiative" has caused most of the pressure instead.

Meanwhile, Skolnick wants some answers about Tenet's pricing strategy as well.

"Can THC ever make money without price increases to drive the earnings?" she ponders. It's a "nasty question, we know, but one that must be asked and answered in some way because it is the obvious criticism."

After all, Skolnick notes, pricing games have backfired on Tenet before. She points to a series of reports that exposed the company's past reliance on Medicare outlier payments. That research, published by UBS analyst Kenneth Weakley, foretold the end to Tenet's success story four years ago.

The company has lost more and more ground ever since.

Skolnick herself remained bearish on Tenet throughout much of that downturn. But she felt encouraged by Tenet's second-quarter progress and -- despite the recent setbacks -- continues to hope for the best.

"If investors sense that we are worried about THC's prospects, they are right; any rational person would be, given the challenges ahead," Skolnick conceded last week. But Tenet "is a company that is trying to do the right thing and the hard thing in the face of industry trends that have brought better positioned companies bad quarters and reduced prospects."

Moreover, "Tenet is a company that has survived many challenges to its very existence over the last four years," she added. "We are not about to give up on it just yet."