HealthSouth's Comeback Flames Out

Updated from 11:13 a.m. EDT

HealthSouth's ( HRC) stint as a value darling was short-lived.

The Birmingham, Ala.-based surgical rehabilitation provider spent much of the last year fighting off perceptions that it is mismanaged, slow to collect bills and engaged in bookkeeping sleight of hand. The effort was starting to pay off: after falling as low as $8 in mid-July, the shares rallied to $12.19 last week as some investors believed they'd found a bargain.

On Tuesday, however, the company dropped a bomb that sent its shares back down to their July lows, falling $5.26, or 44%, to close at $6.71 on volume of more than 42 million shares. Citing changes in the way the government reimburses rehabilitation procedures, HealthSouth said its annual earnings before interest, taxes, depreciation and amortization will probably fall by $175million, making its previous guidance for the current and coming years meaningless. (The company had done about $4.5 billion in revenue and about a half-billion dollars in net income yearly.)

As a result of the government reimbursement changes, HealthSouth will spin off its surgery care unit, making it the largest independent operator of freestanding outpatient surgery centers in the country.

The company's controversial chief executive, Richard Scrushy, who some had argued was poised to lead the company out of its sketchy recent past, was named chairman of the surgery centers, giving up the CEO role at HealthSouth to President and Chief Operating Officer William Owens.

The reimbursement changes date back to a directive issued by the Centers for Medicaid and Medicaid Services on July 1 that required that outpatient therapy services provided to two or more patients in a single time period be paid for as "group therapy." The company said it had been seeking clarification on the change in discussions with regulators, but decided to implement "policies and procedures designed to reflect a conservative interpretation of current Medicare coding requirements in light of the recent directive."

The company hopes that by spinning off the surgery centers, it will shield them from further reimbursement uncertainty.

Things got progressively worse for HealthSouth as the day wore on.

Both Moody's and Standard & Poor's placed their ratings on HealthSouth's more than $3 billion of debt on review for possible downgrade.

Moody's said it was concerned about the potential cash flow impact of both the spin-off of the surgery care unit and the Medicare reimbursement changes.

Any downgrades by Moody's would send HealthSouth's debt ratings further into speculative grade territory.

A one-notch downgrade by S&P would result in the corporate credit and senior unsecured ratings falling below investment-grade.

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