For investors in
-- ahospital chain that's considered a
ripe takeovertarget by some -- one Wall Street expert has issued aclear warning.
In a nutshell, Banc of America analyst Gary Taylorsays this: Buyer, beware. The company could havebigger problems than rising bad debts from theuninsured.
Indeed, when downgrading the company's stock tosell this week, Taylor suggested that Triad has beenplaying accounting games and that the company'sresults -- while clearly lackluster -- could be evenworse than they seem.
"For Triad in particular, we believe bad debt is a'red herring,'" Taylor wrote. "We believe aggressiveprior-period revenue recognition is the primary issuehere -- not the 'societal' issue of the uninsured."
Triad stands behind its accounting anddisagrees with Taylor's report. But Taylor warns that the company's reported profits continue to exceed its actual cash flow by anever-widening margin.
Taylor doesn't necessarily buy Triad's big capital spendingprogram as an excuse, either. Indeed, he says the company's capital spending -- when measured againstits revenues -- is not all that excessive. He justwonders why capital expenditures exceed depreciationby so much.
Taylor offers three possibilities. First, headmits, Triad could be spending large sums on realgrowth opportunities that cut into cash flow withoutlowering earnings quality. But he points out that the company's cashflow per share has not grown along with the outlays.
Taylor says Triad also could instead be using alot of its cash for routine capital spending. Or, he adds, the company could be improperly capitalizing its operating expenses -- and understatingits depreciation expenses -- in a way that makes itsearnings and cash flow look better.
Some Triad critics wonder if the company knowssomething that they don't. Last month, they point out,longtime director Thomas Frist III -- a member of thecompany's audit committee -- abruptly resigned from theboard.
For its part, Triad offers a simple explanationfor that departure: Frist belongs to the familyinvolved in the leveraged buyout of
andresigned from his post at Triad to remove anyimpressions of conflicts.
Still, Taylor is concerned. He dwells onthe company's treatment of self-pay accounts.
"When we asked Triad management on their 3Q06conference call, 'Why don't you book self-pay revenueon a cash basis,' the response was: 'That would be apretty significant chunk of revenue' that we wouldlose," Taylor notes. "But most of it is uncollectiblerevenue.
"And more importantly to investors, it flowsthrough as overstated earnings until it gets reservedfor in future periods via 'non-recurring' charges."
Taylor currently has a $28 price target on Triad'sstock. His firm has provided investment bankingservices to the company over the past 12 months.
Triad shares rose 16 cents to $37.48 on Thursdaybut remain very near their 52-week low.
Sheryl Skolnick, senior vice president of CRTCapital Group, sees both validity and shortcomings inTaylor's call.
Skolnick agrees that Triad's earnings qualitylooks "lousy" and that its cash flow has been weak.But she questions whether poor accounting -- involvingdepreciation or bad debts -- is really to blame.
She notes that Triad emerged as aspinoff from HCA and has been valuing the assets itinherited under "pooled" accounting as a result.Because of this, she says, many Triad hospitals remainon the company's balance sheet with very old bookvalues. In turn, she adds, depreciation expense lookslower than it otherwise would.
Skolnick concedes that Triad could, infact, be treating uninsured revenues -- and the baddebts they create -- too aggressively. But she wonderswhether the company deserves to be singled out.
"My point is that if you condemn Triad for havingvery, very, very large write-offs for bad debts, thenyou better condemn everybody in the hospital space,"says Skolnick, who recommends buying Triad as apossible takeover play. "Every company -- every singleone of them -- has, at some point, been too optimisticor aggressive about recognizing revenues as realizablethat ultimately were not."
Still, Taylor views Triad as more vulnerable thanmost.
He studied the entire sector and concluded that,following recent changes, most hospital companies --including
and HCA -- have establishedadequate reserves to cover shortfalls from bad debts.He portrayed Triad as the only real outlier in thegroup.
"Triad," he says, pointing to a measure of earnings quality, "simply fails ourtests in dramatic fashion."