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Fitch Rates Community Health Systems Senior Secured Notes 'BB/RR1'
March 7, 2017 / 3:11 PM / 9 months ago

Fitch Rates Community Health Systems Senior Secured Notes 'BB/RR1'

(The following statement was released by the rating agency) NEW YORK, March 07 (Fitch) Fitch Ratings has assigned a 'BB/RR1' rating to CHS/Community Health Systems Inc.'s $1.75 billion senior secured notes. Proceeds will be used to refinance existing senior secured notes and secured term loans. The Rating Outlook is Negative. The ratings apply to $15.5 billion of debt outstanding at Dec. 31, 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' 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 7.2x, versus 5.2x prior to the acquisition. During 2016 CHS paid down $1.6 billion of debt primarily 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 net cash proceeds from the announced transactions of about $900 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 $2.13 billion and $2.16 billion EBITDA forecast for CHS for 2017 and 2018, respectively, reflects the loss of a cumulative $3 billion in revenue as a result of the company's portfolio pruning program. On the Q4'16 earnings call, management said they have plans to divest assets that contribute about 15% of 2016 revenue; this includes the $1.8 billion in revenues represented by announced transactions expected to close in early 2017. The divestiture program is a central focus of an operational turn-around 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' 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' organic volume growth by reducing exposure to these lesser acuity volumes. Much like its 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 is a strategy that 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 Dec. 31, 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 likely 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 12.2% and negative 1.6% in 2017 and 2018, 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 associate and minority dividends of $2.13 billion and $2.16 billion in 2017 and 2018, respectively, assumes that the operating EBITDA margin recovers about 100 bps by the end of 2017, to 13.1%, versus the Dec. 31, 2016 LTM level of 12.1%, as the result of divesting less profitable hospitals. --FCF margin of 1.6% in 2017 (same as 2016 level) and improving to above 2% in 2018-2019, benefiting from lower cash interest expense due to debt re-payment, and higher profitability. --Capital intensity of 4.5% in 2017 and rising to 5% by 2019, reflecting an assumption of increased investment in the company's remaining hospital markets. --Total debt/ EBITDA after associate and minority dividends drops below 7x in 2017 due to debt repaid with divestiture proceeds; and there are no issues with maintaining debt covenant compliance during the forecast period. RATING SENSITIVITIES Maintenance of CHS' 'B' IDR considers total debt/EBITDA after associate and minority dividends 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 2017-2020 forecast period. Maintenance of the rating also considers that CHS will generate at least break even FCF. A downgrade to 'B-' could result from total debt/EBITDA after associate and minority dividends durably above 7.0x coupled with a cash flow deficit that requires incremental debt funding. An expectation of total debt/EBITDA after associate and minority dividends 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' same hospital adjusted admissions. LIQUIDITY At Dec. 31, 30, 2016, sources of liquidity included $238 million of cash on hand and $945 million of available capacity on the senior secured credit facility cash flow revolver; the company generated LTM FCF of $301 million. CHS' EBITDA/interest paid is solid for the 'B' rating category at 2.3x. Upcoming debt maturities include an A/R securitization facility with $677 million outstanding at Dec 31, 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. Fitch expects the new $1.75 billion of secured notes will be used to refinance a portion of the 2018 secured debt maturities. 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 taken the following rating actions: Community Health Systems, Inc.: --Issuer Default Rating (IDR) affirmed at 'B'. CHS/Community Health Systems, Inc.: --IDR affirmed at 'B'; --Senior secured credit facility upgraded to 'BB/RR1' from 'BB-/RR2'; --Senior secured notes upgraded to 'BB/RR1' from 'BB-/RR2'; --Senior unsecured notes downgraded to 'CCC+/RR6' from 'B/RR4'. The Rating Outlook is Negative. The 'BB/RR1' rating for CHS' secured debt (which includes the bank term loans, revolver and senior secured notes) reflects Fitch's expectations for 91% recovery under a hypothetical bankruptcy scenario. The 'CCC+/RR6' rating on CHS' $6.1 billion senior unsecured notes reflects Fitch's expectations of no recovery for these lenders in bankruptcy. The changes in the debt issue ratings reflect Fitch's understanding that the equity value of non-guarantor operating subsidiaries would be recovered by the secured debt lenders prior to any residual value flowing to the unsecured lenders. Fitch's recovery waterfall reflects this assumption based on terms in the credit facility collateral and pledge agreement. 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 2017 forecasted EBITDA less distributions to non-controlling interests of $2.048 billion for CHS, resulting in a going concern EBITDA estimate of $1.43 billion. Fitch applies a 7x multiple to CHS' going concern EBITDA, resulting in an enterprise value (EV) of $10 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 available balances on the bank credit revolver and the A/R securitization facility in a bankruptcy scenario and includes those amounts 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 billion. Secured claims, including the A/R securitization, the bank revolver, term loans and senior secured notes are assumed to be $9.9 billion, leaving no value for unsecured lenders. Contact: Primary Analyst Megan Neuburger, CFA Managing Director +1-212-908-0501 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Britton Costa, CFA Director +1-212-908-0524 Committee Chairperson Michael Paladino, CFA Managing Director +1-212-908-9113 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. 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