NEW YORK--(BUSINESS WIRE)--Fitch Ratings does not expect any change to HCA Holdings, Inc.'s (HCA) ratings, including the 'B+' Issuer Default Rating (IDR), due to the repurchase of $750 million of shares from the sponsors of a 2006 leveraged buyout (LBO). The Rating Outlook is Positive. A full rating list is shown below. The ratings apply to $28.9 billion of debt outstanding at March 31, 2014.
HCA plans to fund the share repurchase through draws on the bank credit revolvers and cash on hand, resulting in about a 0.1x increase in total debt-to-EBITDA. Considering the increase in debt to fund the share repurchase, pro forma gross debt leverage is about 4.4x. The draw on the credit revolvers also does not affect Fitch's recovery analysis for HCA, which is discussed in detail below.
The sponsors of the LBO have been actively liquidating their positions in the company since a March 2011 IPO. Along with the share repurchase by HCA, Bain Capital Partners, LLC (Bain) and Kohlberg Kravis Roberts & Co. (KKR) will sell 15 million shares to the public. Prior to the share repurchase and public equity offering, Bain and KKR own a combined 13.5% of HCA's public equity value. As a result of the transactions, the ownership percentage will drop to about 6%.
Under the direction of the LBO sponsors, HCA's ratings have been constrained by shareholder-friendly capital deployment; the company funded $7.4 billion in special dividends since 2010 that were mostly debt financed. Due to the reduced ownership percentage of the sponsors, SEC regulations required the company to appoint a majority of independent directors to the Board during 2014; HCA has recently appointed four new independent members to the 13-member board, bringing the total to seven.
Fitch revised HCA's Rating Outlook to Positive in August 2013, indicating that a one-notch upgrade to 'BB-' is likely during 2014. A positive rating action will require HCA to maintain debt at or below 4.5x EBITDA. Although Fitch does not expect a major departure in strategic direction under an independent board, there may be some shifts in the company's capital deployment strategy. A more consistent and conservative approach to funding shareholder pay-outs in the form of special dividends and share repurchases would support an upgrade.
Other factors that would support an upgrade of the ratings include sustained improvement in organic acute care operating trends, better clarity on the effects of the Affordable Care Act (ACA) on operating results and sustained solid cash generation. Fitch forecasts HCA will produce discretionary free cash flow (cash from operations less capital expenditures but before dividends) of $1.5 billion in 2014, and expects the company to prioritize acquisitions and shareholder payouts as cash usages. At the current level, HCA's debt leverage is consistent with peer companies and Fitch does not believe that there is a compelling financial incentive for the company to apply cash to debt reduction.
HCA's organic growth in patient volumes has outpaced that of the broader for-profit hospital industry over the past several years, although the company has not been entirely resilient to headwinds to organic growth. Facing a stiff comparison to strong growth in early 2013, HCA's growth in organic patient volumes in the first quarter of 2014 (1Q'14) was softer than in recent periods, with same-hospital adjusted admissions dropping 0.3%. The recent softness in HCA's same-hospital volumes would be more concerning if it were accompanied by weaker growth in pricing, but this metric showed improvement starting in late 2013.
HCA's 1Q'14 results did not benefit significantly from the initial implementation of the insurance expansion elements of the ACA. While Fitch currently forecasts revenue and EBITDA growth across the group of for-profit hospital companies in 2014 due to the ACA, estimating the precise effects is complicated by uncertainty over the pace and progress of the growth of the insured population. The benefits of reform for HCA are dampened by the company's geographic exposure; only four states in which HCA operates (California, Colorado, Kentucky and Nevada, 12.6% of licensed beds) elected to expand Medicaid eligibility effective Jan. 1, 2014, which limits the potential decrease in self-pay patients and the associated financial headwind of bad debt expense.
DEBT ISSUE RATINGS AND RECOVERY ANALYSIS
Fitch currently rates HCA as follows:
HCA, Inc.
--IDR 'B+';
--Senior secured credit facilities (cash flow and asset backed) 'BB+/RR1' (100% estimated recovery);
--Senior secured first lien notes 'BB+/RR1' (100% estimated recovery);
--Senior unsecured notes 'BB-/RR3' (69% estimated recovery).
HCA Holdings Inc.
--IDR 'B+';
--Senior unsecured notes 'B-/RR6' (0% estimated recovery).
The recovery ratings are based on a financial distress scenario which assumes that value for HCA's creditors will be maximized as a going concern (rather than a liquidation scenario). Fitch estimates a post-default EBITDA for HCA of $3.9 billion, which is a 42% haircut from the March 31, 2014 LTM EBITDA level of $6.8 billion. Fitch's post-default cash flow estimate for companies in the hospital sector considers the structure of the industry, including relatively stable and non-cyclical cash flows and a high level of exposure to cuts in government payor reimbursement that makes up 30%-40% of revenues, offset by the consideration that hospital care is a critical public service.
Fitch then applies a 7.0x multiple to post-default EBITDA, resulting in a post-default EV of $27.5 billion for HCA. The multiple is based on observation of both recent transactions/takeout and public market multiples in the healthcare industry. Fitch significantly haircuts the transaction/takeout multiple assigned to healthcare providers since transactions in this part of the healthcare industry tend to command lower multiples. The 7.0x multiple also considers recent trends in the public equity market multiples for healthcare providers.
Fitch applies a waterfall analysis to the post-default EV based on the relative claims of the debt in the capital structure. Administrative claims are assumed to consume $2.7 billion or 10% of post-default EV, which is a standard assumption in Fitch's recovery analysis. Fitch assumes that HCA would fully draw the $2 billion available balance on its cash flow revolver and 50% of the $2.5 billion available balance on its asset backed lending (ABL) facility. The availability on the ABL facility is based on eligible accounts receivable as defined per the credit agreement. The 50% assumed draw on the ABL facility reflects Fitch's assumption of some degradation in the ABL borrowing base as the company approaches default.
The 'BB+/RR1' rating for HCA's secured debt (which includes the bank credit facilities and the first lien notes) reflects Fitch's expectations for 100% recovery under a bankruptcy scenario. Claims under the ABL facility are assumed to be recovered fully prior to any recovery of the other first-lien debt, including the cash flow revolver, cash flow term loans and first lien secured notes. The 'BB-/RR3' rating on HCA Inc.'s unsecured notes rating reflects Fitch's expectations for recovery in the 51%-70% range. The 'B-/RR6' rating on the HCA Holdings, Inc. unsecured notes reflects expectation of 0% recovery.
HCA's debt agreements permit the company to issue first lien secured debt up to an amount equal to 3.75x EBITDA. At March 31, 2014, Fitch estimates the company had $9 billion in first lien capacity. Additional first lien debt issuance would result in lower recovery for the HCA Inc. unsecured note holders. Under Fitch's current recovery model assumptions, the company could increase its outstanding first lien debt by up to $1.3 billion without diminishing recovery prospects for the HCA Inc. unsecured note holders to below the 'RR3' recovery band of 51%-70%. Should the company increase the amount of secured debt in the capital structure by more than that amount, Fitch would likely downgrade the HCA Inc. unsecured notes by one-notch, to 'B+/RR4'. The ratings on the secured debt and HCA Holdings Inc. unsecured notes would not be affected.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Hospitals Credit Diagnosis' (April 10, 2014);
--'High-Yield Healthcare Checkup' (April 4, 2014);
-- Fitch Rates HCA's Proposed Senior Secured Notes 'BB+/RR1' (March 3, 2014)
--'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013);.
--U.S. Leveraged Finance Spotlight Series: HCA Holdings, Inc. (Nov. 7, 2013);
--'For Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices' (Oct. 24, 2013);
--'Margin Preservation Strategies: Different Angles (U.S. Hospitals and Health Insurers)' (Oct. 1, 2013);
--'The Affordable Care Act and Healthcare Providers: Assessing the Potential Impact' (May 1, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Hospitals Credit Diagnosis (Consolidation Supports Growth in a Weak Organic Operating Environment)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=745816
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=736356
2014 Outlook: U.S. Healthcare - Secular Challenges Require a Compelling Value Proposition
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724141
U.S. Leveraged Finance Spotlight Series - HCA Holdings, Inc.
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721356
For-Profit Hospital Insights (Fitch's Annual Review of Bad Debt Accounting Policies and Practices)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721280
Margin Preservation Strategies - Different Angles (Credit Implications for U.S. Hospitals and Health Insurers)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=718975
The Affordable Care Act and Healthcare Providers (Assessing the Potential Impact)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706654
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
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