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Fitch Rates Team Health's Sr. Unsec. Notes 'B-/RR5'
January 9, 2017 / 5:20 PM / a year ago

Fitch Rates Team Health's Sr. Unsec. Notes 'B-/RR5'

(The following statement was released by the rating agency) NEW YORK, January 09 (Fitch) Fitch Ratings has assigned a 'B-/RR5' rating to Team Health Holdings, Inc's (TeamHealth) $1.015 billion senior unsecured notes due 2025. A full list of TeamHealth's ratings follows at the end of this release. The ratings incorporate the planned acquisition of the company by private equity sponsor Blackstone. The purchase of TeamHealth's equity and the retirement of the company's existing debt will be funded by the senior unsecured notes, a senior secured credit facility consisting of a $2.6 billion term loan and $400 million revolver, and a $2.6 billion equity contribution from Blackstone. KEY RATING DRIVERS TeamHealth's 'B' IDR reflects: High Leverage post-LBO: Gross debt/EBITDA is expected to peak near 8x immediately following the acquisition by Blackstone, but strong top-line growth on modestly improving margins should drive deleveraging of two turns of EBITDA by year-end 2018. However, there are some risks to the deleveraging trajectory. These include synergy capture as the company continues to integrate IPC (a business acquired in late 2015), and uncertainty about M&A appetite under private equity ownership. Leading Position in Growing Market: TeamHealth is one of only a handful of national providers of outsourced healthcare staffing, providing scale and scope for contracting with consolidating healthcare providers and commercial health insurers. Leading scale affords good growth opportunities, both organic and inorganic in nature, even as Amsurg and Envision - two of TeamHealth's major competitors - recently completed a merger. IPC Acquisition Has Mixed Implications: TeamHealth more than doubled leverage in late 2015 to fund the acquisition of IPC, a national provider of outsourced acute care hospitalist and post-acute care providers. Difficulties in physician retention have been a headwind to synergy capture in the early going, though the deal continues to have good strategic merit. The addition of IPC significantly broadened TeamHealth's coverage across the care continuum from the emergency department through the stages of inpatient and post-acute care, and this should increase cross-selling opportunities with the health systems that are TeamHealth's customers. Solid Cash Generation: Free cash flow (FCF; CFO less capital expenditures and dividends) is expected to be strong for the 'B' rating category, only moderately affected by higher interest costs post-LBO. Low working capital and capital spending requirements and the expectation of no dividend payments in the near term support relatively strong cash generation, albeit somewhat pressured in 2016 and moderately reduced by higher interest costs post-LBO. Internal FCF and external liquidity are adequate, in our view, for the firm to bolster organic growth through tuck-in M&A as the physician services segment continues to consolidate. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for TeamHealth include: --Mid-single-digit base revenue growth in 2017 through 2019 reflects an expectation of steady same-contract growth and net new contract wins in the hospital based and IPC segments. High single-digit total revenue growth reflects ongoing cash deployment for tuck-in acquisitions through the projection period. --EBITDA margins gradually expand during 2017-2019 due to improving SG&A and despite moderately pressured gross profit in 2016-2017, easing over the course of 2017-2018 as IPC cost synergies are realized, physician retention is remedied, and transaction costs are annualized. --Cash generation is reduced by increased interest costs (forecast assumes $156 million in 2016 and $185 million in 2017 vs. $24 million in 2015), offset by lower cash taxes in 2017 from deductible transaction expenses, resulting in a FCF margin of 3% to 4%. --Assume $100 million to $125 million of FCF is used for tuck-in M&A annually, with the remainder used to prepay the term loan. --Gross debt/EBITDA drops below 7x in 2017 and below 6x at year-end 2018. FFO fixed charge coverage steady is between 2x and 2.5x. RATING SENSITIVITIES An upgrade of TeamHealth's IDR to 'B+' could occur in the next 12-18 months if there is a high degree of certainty that gross debt/EBITDA after dividends to associates and minorities will decline to below 6x in 2018, coupled with FFO fixed charge coverage of at least 2x. Fitch believes this magnitude of deleveraging is possible based on its ratings case forecasted growth in EBITDA and will not require much debt repayment, but also that there are certain execution risks, including realization of IPC-related cost synergies and addressing IPC's physician attrition issue. An upgrade of the rating would also look for TeamHealth to generate consistently positive FCF, with a FCF margin of 3% to 4%. Maintenance of the 'B' IDR could result from an expectation that deleveraging post the LBO will be slower than expected, leading to gross debt/EBITDA after dividends to associates and minorities durably above 6x, coupled with FCF that is close to or at breakeven. An expectation of gross debt/EBITDA after dividends to associates and minorities sustained above 7x coupled with a FCF deficit that requires incremental debt funding could lead to a downgrade to 'B-'. LIQUIDITY Team Health does not carry large cash balances, but also does not need to due to its low fixed-cost operating model. As a service provider that mainly utilizes clients' buildings and equipment, Team Health does not have heavy fixed costs or require large capital expenditures. Capex tends to be only around 1% of revenue, and Fitch does not expect this dynamic to change in the near term. A $400 million revolver will be downsized from $650 million post the LBO, but will provide adequate internal liquidity for day-to-day needs and tuck-in M&A. FCF generation is relatively steady, though higher interest costs will reduce FCF margin to 3%-4% from the previous 5%-6% range. LTM FCF at Sept. 30, 2016 was $92 million. Based on the post-LBO capital structure, near-term debt maturities are expected to include only required term loan amortization, which FCF should amply cover. FULL LIST OF RATING ACTIONS Fitch rates TeamHealth as follows: Team Health Holdings, Inc. --IDR 'B'; --Senior secured credit facility including term loan and revolver 'BB'/RR1'. Fitch is assigning the following rating: --Senior unsecured notes 'B-/RR5'. The Outlook is Positive. The 'BB/RR1' rating on the secured credit facility assumes 94% recovery for lenders in a hypothetical bankruptcy scenario. The 'B-/RR5' rating on the senior unsecured notes assumes 15% recovery. The recovery analysis assumes a going concern enterprise value (EV) for TeamHealth of $3.3 billion. The EV is derived by taking a 40% discount to Fitch's 2018 forecasted EBITDA and then applying a 9x multiple. Administrative claims are assumed to consume 10% of EV, which is a standard assumption in Fitch's recovery analysis. Also standard in its analysis, Fitch assumes that TeamHealth would fully draw the $400 million available balance on its bank credit revolver in a bankruptcy scenario and includes that amount in the claims waterfall. Recovery for the notes is limited to a 5% concession allocation granted to the unsecured lenders, given the assumption of no recovery otherwise. Contact: 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 Ellen Itskovitz Senior Director +1-312-368-3118 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: 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 $9.9 million in non-cash stock-based compensation to the EBITDA calculation. 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