Turnaround Takes a Detour at Tenet

The hospital chain posts deteriorating numbers and sees its young finance chief depart.
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Ailing

Tenet

(THC) - Get Report

is suffering from somemajor complications.

It is bleeding more than many observers hadimagined. It is losing its young CFO. And it is facing additional government probes.

The giant hospital chain announced on Tuesday thatits second-quarter loss had more than doubled from ayear ago, to $426 million. Even without a slew ofspecial charges -- including another big provision fordoubtful accounts -- the company posted asecond-quarter operating loss of 6 cents a share thatwas a nickel worse than Wall Street was anticipating.Moreover, Tenet excluded two items, totaling 5 cents ashare, that were viewed as clearly operational bysome.

"Financially, I don't see anything in here thateven the staunchest bull could hang his hat on," saidJeff Villwock, an analyst at Caymus Partners whoconducts research on behalf of a shareholder groupthat's critical of the company.

Tenet's stock tumbled 4.7% to $10.66 after Tuesday's financial update.

Stability

But Tenet itself highlighted at least one positive development. It reported that managed care pricing -- hurt by the company's past aggressiveness -- finally appears to be stabilizing.

"In the current quarter, we have achieved essentially flat year-over-year pricing with our managed care business partners," Tenet CEO Trevor Fetter said. "This exceeds my recent expectations for the time it would take to rebuild our managed care relationships and bodes well for our revenue growth going forward."

Fetter also celebrated the company's cost-control efforts and even pointed to bad debt expense -- while up for the quarter -- as "somewhat better" than he had anticipated.

Tuesday's earnings came after Tenet revealed thatStephen Farber will soon vacate the CFO seat heassumed when the company's business practices firstcame under fire in late 2002. Farber has decided toleave the company, rather than join a corporaterelocation to Dallas, and return to Wall Streetinstead. The 35-year-old Farber originally joinedTenet as senior vice president and treasurer in 1999after an early career in investment banking.

Villwock called Farber's departure "interesting."

"He's a very young guy," Villwock noted. "I wouldthink that maintaining his position as CFO of a $10billion company, with the potential to become CEO inanother generation ... would be a terrificopportunity, given the way that people get paid aroundthere."

Farber earned $727,000 last year. But Fettercollected a much more generous $6.12 million as thetop executive of the troubled company.

Farber follows former TenetVice Chairman Barry Schochet -- who announced hisretirement last week -- out of the executive suite.Farber said on Tuesday that he will leave with "afeeling of real accomplishment" as the company pavesthe way for future growth. Meanwhile, Fetter praisedFarber for "helping Tenet

tostrengthen its financial footing and business strategyduring some very difficult times."

'Huge'

Still, the difficulties keep piling up. In aregulatory filing on Tuesday, Tenet revealed that government officials are now reviewing the company's past formula for calculating generous Medicare outlier payments at its Philadelphia-area hospitals. Villwock says the "huge" outliers collected in Philadelphia could mean that Tenet overbilled Medicare even more than he first imagined. He previously estimated that Tenet could wind up returning $2 billion worth of outlier checks.

Tenet also disclosed that federal prosecutors are now investigating three of its hospitals in New Orleans. In addition, it said that two of its former hospitals, now under new ownership, are under government scrutiny as well. Some critics wonder whether the latter investigation will further hamper Tenet's efforts to

shed many of its underperforming facilities.

A group of physicians known as HA005 recently indicated that they may soon gain control of three of the Los Angeles-area facilities, however.

"While we are strictly limited in what we may disclose, it does look like we will attain our original objective of securing the hospitals and maintaining services for our communities," HA005 Chairman Michael Finnigan wrote last week to the group's members.

Finnigan said that HA005 had already depleted the $445,000 raised by its members to pursue the acquisition. But he said that an outside investor, named Westridge Partners, "will be picking up costs from here to the closing date."

The group is hoping to snag three Tenet hospitals -- Centinela Hospital Medical Center, Daniel Freeman Memorial Hospital and Daniel Freeman Marina Hospital -- that are among those under government scrutiny.

Ragin' Cajuns

Meanwhile, the U.S. attorney in New Orleans isseeking information about physician relationships andfinancial arrangements at three Tenet-owned facilitiesthere. Peter Urbanowicz, Tenet's general counsel, said the inquiry is related to an ongoing probe of the company's HMO in New Orleans.

"It's an outgrowth of the investigation disclosed last year," he told analysts during a conference call on Tuesday. "We continue to be involved in discussions on nearly a daily basis with federal law enforcement officials."

Peter Young, a business consultant who caters to the hospital industry, spotted fresh cause for alarm.

"There is

already physician migration to competing facilities ... as reflected in declined admissions," Young stated. "Add yet another subpoena directed at physician relationships -- the ultimate driver of hospital revenue -- and more physician migration is ahead, as physicians realize the company's precarious financial standing with continued regulatory review."

By now, a number of Tenet hospitals aresuspected of paying physicians illegal kickbacks inexchange for patient referrals. One of those, AlvaradoHospital Medical Center in San Diego, faces a

criminal trial on the kickback charges just two months from now.

Tenet warned on Tuesday that a conviction couldbar Alvarado from government insurance programs andtrigger monetary penalties. The company also remindedinvestors of the threat posed by governmentinvestigations and civil litigation overall.

"If adversely determined," the company stated,"the outcome of these matters could have a materialadverse effect on our liquidity, financial position orresults of operations."

But Tenet's performance is already suffering.After showing fresh signs of life -- and

sparking investor hope -- just one quarter ago, the company reported that its operating loss had more than tripled in the latest period. Bad-debt expense, which eased back earlier this year, re-emerged as a major culprit by chewing through nearly 20% of the company's net revenue.

Revenue itself was down aswell. Hit by declining admissions and an unfavorablepatient mix, Tenet reported second-quarter revenue of$2.57 billion, 3.3% below last year's levels, andmissed analyst expectations by $40 million.

Villwock called Tenet's same-store admissiondecline "certainly the worst" among urban hospitalchains reporting numbers to Wall Street. Meanwhile, Young continued to warn onTuesday about the financial condition of the company.

"Same-facility performance indicates a seriousfundamental deterioration of business, with admissionsfor both inpatients and outpatients down and costs upamidst flat revenue," Young said. "The implicationsare huge for Tenet going forward."

Inpatient admissions slid 3%, and outpatientadmissions fell 3.3% during the latest quarter. Onlyuninsured admissions -- for which Tenet can expectlittle payment -- actually inched ahead.

"The fastest-growing sections of the operatingstatement are bad debts and costs," Young marveled.

Even excluding special charges -- which clearlyhurt second-quarter results -- Tenet is spending a lotof money just to stay in business.

"Operating expenses, exclusive of impairment oflong-lived assets and goodwill and restructuringcharges, were 108.4% of net operating revenues in thequarter ended June 30, 2004," the company disclosed.

Young believes the company's situation will onlygrow worse. But Tenet itself remains optimistic.

"As I look at the quarter, a number of items areevident demonstrating both interim success stories aswell as highlighting areas where more work needs to bedone," Fetter stated. "While much remains to be done,the current quarter demonstrates that we are on theright track, and that our people can take pride in theprogress that has been achieved thus far."