Community Health Systems Inc (CYH)

[seasonedwell]

NEW YORK, December 29 (Fitch) Fitch Ratings has removed the ratings of Community Health Systems, Inc. (CHS) from Rating Watch Evolving and has affirmed the Issuer Default Rating (IDR) at 'B'. The Rating Outlook is Negative. The ratings apply to $15.5 billion of debt outstanding at Sept. 30, 2016. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Persistent Credit Profile Headwinds: The Negative Outlook reflects CHS's high leverage, weak operating trends since the acquisition of rival hospital operator Health Management Associates (HMA) in late 2014, and execution risk surrounding a divestiture and business repositioning plan in some of the company's markets. Growth in EBITDA has also been hampered by ongoing government investigations and lawsuits. Lingering High Leverage: Progress towards deleveraging has been slow since the HMA acquisition; total debt/EBITDA is about 7.4x, versus 5.2x prior to the acquisition. So far in 2016, CHS has paid down about $1.6 billion of debt with the proceeds from the spin-off of Quorum Health Corporation (QHC) and the sale of a minority interest in several hospitals in Las Vegas. This was the first substantial debt repayment since the HMA acquisition. Ongoing Divestiture Program: CHS has completed or announced further asset sales, including divestiture of several more hospitals, some medical office buildings and an 80% share of its home health business. Most of these transactions are expected to close in Q1'17, and Fitch estimates cash proceeds of about $800 million. A recent amendment to the terms of the credit facilities requires that asset sale proceeds are used to repay term loan borrowings. Lower EBITDA, More Profitable Portfolio: Fitch's $2.18 billion and $2.16 billion EBITDA forecast for CHS for 2016 and 2017, respectively, reflects the loss of a cumulative $1.5 billion in revenue as a result of the company's portfolio pruning program. After completing the QHC spin-off, management said they have plans to divest assets that contribute about $2 billion of revenue; this includes the pending transactions expected to close in early-mid 2017. The divestiture program is a central focus of an operational turnaround plan to improve same hospital margins and sharpen focus on a subset of core markets with better organic operating prospects. Headwinds to Less Acute Volumes: CHS's legacy hospital portfolio is exposed to small rural markets facing secular headwinds to lesser acuity patient volumes. Volume trends in the company's markets are highly susceptible to weak macro-economic conditions and seasonal influences on flu and respiratory cases. Health insurers and government payors have been increasing scrutiny of short stay admissions and preventable hospital readmissions. CHS has made some headway in turning around industry lagging volume trends, but these challenges have proven difficult to overcome. Repositioning Portfolio Should Help: Repositioning the portfolio around larger, faster growing markets should help CHS's organic volume growth by reducing exposure to these lesser acuity volumes. Much like CHS's peers in larger hospital markets, the company is shifting the investment focus to building comprehensive networks of inpatient and outpatient facilities to capture share in certain targeted markets. This strategy is aligned with secular trends in healthcare delivery and should benefit the operating profile. However, successful execution of this repositioning is not without challenges from both an operational execution and capital investment perspective and is occurring at a time when cash flow generation is depressed relative to historical levels and management is still grappling with HMA integration issues. Progress in Resolution of Legal Issues: CHS has been dealing with government investigations and lawsuits related to the issue of short-stay hospital admissions. CHS has made good progress in resolving the legal issues facing the legacy CHS hospitals, which did not involve financial fines significant enough to threaten financial flexibility and provided some comfort that the scope of the potential HMA fines or penalties will be similarly manageable. The timing of cash payment to settle the HMA liabilities is uncertain. At Sept. 30, 2016, CHS has recorded a $260 million reserve for potential financial payment associated with these cases. Based on the size of the financial settlement negotiated for the legacy CHS hospitals, Fitch thinks the reserve is adequate to cover the eventual penalty, although there is a tail risk scenario where the payment is greater. The reserve also mirrors the size of the contingent value right agreed to as part of the HMA acquisition, which essentially establishes a floor on the payment amount. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for CHS include: --Top line growth of negative 6.1% and negative 10.5% in 2016 and 2017, respectively, reflects completed and planned divestitures. Underlying same hospital growth of 1%-2% is driven by pricing as patient volumes are assumed to be flat at best and slightly down in most payor classes. --EBITDA before dividends to associates and minorities of $2.18 billion and $2.16 billion in 2016 and 2017, respectively, assumes that the operating EBITDA margin recovers about 150 bps by the end of 2017, to 13.2%, versus the Sept. 30, 2016 LTM level of 11.7%, mostly as the result of divesting less profitable hospitals. --FCF recovers somewhat, and is weakly positive in 2016, benefiting from lower cash interest expense due to debt re-payment, and lower capital intensity based on management's projections for capital expenditures of about 4.5% of revenues in 2016. --Total debt to EBITDA after dividends to associates and minorities drops below 7x in 2017 due to debt repaid with divestiture proceeds; and there are no issues with maintaining debt covenant compliance during the 2016-2019 forecast period. RATING SENSITIVITIES Maintenance of CHS's 'B' IDR considers gross debt/EBITDA after dividends to associates and minorities slowly declining to about 6.5x over the next several years, primarily due to debt reduction in 2017 and slight growth of EBITDA due to stabilizing operating trends in the outer years of the 2016-2019 forecast period. Maintenance of the rating also considers that CHS will generate at least break even FCF. A downgrade to 'B-' could result from gross debt/EBITDA after dividends to associates and minorities durably above 7.0x coupled with a cash flow deficit that requires incremental debt funding. An expectation of gross debt/EBITDA after dividends to associates and minorities sustained near 5.5x and a FCF margin of 3%-4% could result in an upgrade to 'B+'. Risks to the operating outlook include the inability of management to execute on operational improvements necessary to improve organic volume growth and profitability. This could be evidenced by difficultly completing the remaining planned divestitures and associated debt pay-down, and/or sustained negative growth in CHS's organic adjusted admissions. LIQUIDITY At Sept. 30, 2016, sources of liquidity included $133 million of cash on hand, $912 million of available capacity on the senior secured credit facility cash flow revolver and LTM FCF of $198 million. CHS's EBITDA/interest paid is solid for the 'B' rating category at 2.2x. Upcoming debt maturities include the A/R facility with $634 million outstanding at Sept. 30, 2016; $250 million of the $700 million A/R funding commitment matures November 2017 and the remaining $450 million matures November 2018. The 2018-2019 maturity schedule includes $2.2 billion of maturities in 2018 and $3.5 billion in 2019. The upcoming maturities are all secured debt with the exception of $1.9 billion of unsecured notes maturing in 2019; the terms of the unsecured note indentures do limit the company's ability to refinance unsecured debt with secured debt. CHS was granted an amendment to the terms of the credit agreement by the bank lenders during Q4'16 to give near-term relief on the financial maintenance covenant levels. There was no increase in pricing, but the credit enhancements for the lenders strengthened the conditions under which the company is required to use divestiture proceeds to reduce debt, which is a near-term positive from a credit profile perspective. Despite the forecasted decline in EBITDA in the ratings case, Fitch expects the company to remain in compliance with the financial maintenance covenants through the projection period. FULL LIST OF RATING ACTIONS Fitch has removed from Rating Evolving and affirmed the following ratings: Community Health Systems, Inc. --IDR at 'B' CHS/Community Health Systems, Inc. --IDR at 'B'; --Senior secured credit facility at 'BB-/RR2'; --Senior secured notes at 'BB-/RR2'; --Senior unsecured notes at 'B/RR4'. The Rating Outlook is Negative. The 'BB-/RR2' rating for CHS's secured debt (which includes the bank term loans, revolver and senior secured notes) reflects Fitch's expectations for 74% recovery under a hypothetical bankruptcy scenario. The 'B/RR4' rating on CHS's $6.1 billion senior unsecured notes reflects Fitch's expectations for principal recovery of 37%. In the U.S. healthcare sector, Fitch consistently uses a going-concern approach to valuation as opposed to assuming a liquidation value; intrinsic value is assumed to be greater than liquidation value for these companies, implying that the most likely outcome post-default would be reorganization rather than liquidation. The going-concern cash flow (measured by EBITDA) estimate assumes an initial deterioration that provokes a default which is somewhat offset by corrective actions that would take place during restructuring. Fitch assumes a 30% discount to its 2016 forecasted EBITDA less distributions to non-controlling interests of $2.1 billion for CHS, resulting in a going concern EBITDA estimate of $1.5 billion. Fitch applies a 7x multiple to CHS's going concern EBITDA, resulting in an enterprise value (EV) of $10.2 billion. The 7x multiple is based on observation of both recent transactions/takeout and public market multiples in the healthcare industry. Administrative claims are assumed to consume 10%, or about $1 billion of EV, which is a standard assumption in Fitch's recovery analysis. Also standard in its analysis, Fitch assumes that CHS would fully draw the $1 billion available balance on its bank credit revolver in a bankruptcy scenario and includes that amount in the claims waterfall. Fitch applies a waterfall analysis to the going-concern EV based on the relative claims of the debt in the capital structure. Fitch estimates EV available for claims of $9.2 billion. At Sept. 30 2016, about 60% of consolidated net revenue resides in the guarantor group, so Fitch assumes that 60% of the EV, or $5.5 billion, is recovered by first-lien secured holders, leaving $3.7 billion of non-collateral value to be distributed to unsecured claimants. Based on $9.5 billion of total secured claims (which includes the bank term loans, revolver and senior secured notes), the resulting first-lien secured deficiency claim of $3.9 billion is added to $6.1 billion of senior unsecured claims, resulting in $10.1 billion of total unsecured claims, recovery of which is assumed on a pro rata basis. Contact: Primary Analyst Megan Neuburger, CFA Managing Director [phone] Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Britton Costa, CFA Director [phone] Committee Chairperson John Kempf Senior Director [phone] Media Relations: Alyssa Castelli, New York, Tel: [phone], Email: [e-mail]. Additional information is available on www.fitchratings.com Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation. In 2015, Fitch added back $59 million in non-cash stock-based compensation to the EBITDA calculation. Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017123 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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