Tenet Healthcare Corporation (NYSE:THC)
The 30th Annual JPMorgan Chase Healthcare Conference
January 09, 2012 2:30 pm ET
Trevor Fetter - Chief Executive Officer, President, Director and Member of Executive Committee
John F. Rex - JP Morgan Chase & Co, Research Division
John F. Rex - JP Morgan Chase & Co, Research Division
All right, I think that's our signal to go. Thanks for joining us, my name is John Rex. I cover the healthcare facility stocks here for JPMorgan. Up next is Tenet Healthcare. Trevor Fetter is the CEO. Seemingly, if I go back a year ago, it seems almost like a sedate year at this point compared to where we were. But I will turn the time to Trevor.
Thank you, John. Good morning, everyone. It's a full room here, about as many empty seats as in the Starbucks across the street, but it's a great turnout, I'm pleased to be here. I'm going to begin -- well, if the slide advancing device will work. No.
Okay. So I would call your attention to this slide, just because I'm going to be making some forward-looking statements today and there's some valuable cautionary language on the forward-looking statement slide.
So just to begin with our business model, one of the most important points that I want to make today is that Tenet's business model is taking on new dimensions, extending well beyond our 50 acute care hospitals. While our 50 hospitals and nearly 100 outpatient centers across 13 states remain the backbone of our earnings power, we expect that our future growth will include much greater emphasis on both the outpatient business and our rapidly growing services business, which the latter operates under the brand name Conifer.
The emphasis on outpatient and services is designed to accelerate growth, increase margins and create earnings that are more stable and predictable. We believe this strategy can provide significant growth in shareholder value. It's important to understand that with the exception of a limited number of outpatient acquisitions through the end of 2012, our long-term earnings guidance is driven purely by organic growth. Over the next 4 years, our performance is likely to be enhanced by acquisitions, but unless the acquisition target is individually identified, we did not include it in our outlook.
This map illustrates the scope of our hospital and outpatient businesses. We're well positioned in sunbelt markets and should experience superior growth as the national economy emerges from the recession. You should reach a couple of conclusions from looking at this map. First, we have a geographically diversified portfolio across multiple attractive markets; and second, where we compete, we devote meaningful resources to the market. We also operate in several markets with high proportions of uninsured patients, which becomes an asset as coverage is expanded post-2013.
Our strategy is to build competitive scale, generating both operating efficiencies and an attractive negotiating position with commercial payers. The hospital business, as you know, is a local business, and the best way to assess market relevance is really at the service line level. This service line perspective is fundamental to Tenet's targeted growth initiative, or TGI, and reflects the way that competitive strength is really built.
This chart shows the markets in which we have a #1 or #2 position. Out of the 24 markets that we serve, we're #1 in 11 markets and #2 in another 2 markets. If you calculate the average market share in every Tenet hospital in their primary service areas, or PSAs, the average is 20%. Four of our hospitals have a market share of 50% or greater in their PSAs, and 18 of our hospitals have a market share of 20% or greater.
Now it's often service lines that matter most. Examples are markets like Philadelphia, where we're #2 in children's services in a market that otherwise looks saturated with general hospitals. We're in several markets where we operate unique services like high-level trauma units. It's Tenet's collection of differentiated service line strength that creates value in the eyes of physicians and commercial payers. We of course also have hospitals that are market leaders across very broad service lines or have limited competition. Whether it's one critical service line or broad-based strength, we have many hospitals that are essential to managed care networks. These are the so-called "must have" hospitals. By negotiating on a statewide or national basis on many of our managed care contracts, we fully leverage those must-have hospitals. This, together with our superior value proposition, is why we've reported such good commercial pricing trends over the last several years.
This map on Slide 6 illustrates the scope of Conifer's business. It also illustrates a key reason for Conifer's superior performance in the revenue cycle: centralized and highly specialized operation centers. Several years ago, we completed the process of centralizing our revenue cycle functions. This is a key differentiating factor in Conifer's approach to revenue cycle outsourcing. Conifer Revenue Cycle Services is responsible for the revenue cycle at 100 unique healthcare entities, including Tenet's 50 acute care hospitals. In addition to our Revenue Cycle business, Conifer also includes a patient communications business that serves more than 200 unique healthcare entities. This business offers a variety of services including everything from patient scheduling to assisting healthcare professionals in their use of the INTERQUAL system.
Capitation management capabilities are also included among Conifer's service offerings. Cap Management Systems has been doing business for more than 20 years and currently serves 24 unique healthcare entities. We'll see increasing demand for their services as healthcare moves toward more integrated models, including accountable care organizations.
So across these product lines, Conifer Health Solutions serves a total of more than 300 healthcare entities. As we think about Tenet's future growth, I could see this number rising to 500 or more just over the next few years. Our services businesses represent a very efficient deployment of our capital, and Conifer can be expected to provide an important contribution to EBITDA growth over the next 5 years.
So we plan to release earnings and hold our fourth quarter conference call on February 28. But earlier this morning, we issued a press release with some highlights. First, we've provided a partial update on our fourth quarter of 2011. CMS granted final approvals at the end of the year, so we recorded $28 million from the California Provider Fee in the fourth quarter. While we are pleased to have certainty on this important item, there are other issues that are still pending. Most importantly, we continue to reach favorable payer settlements, which could have a large impact on our fourth quarter. We've negotiated agreements in principle but still need final approvals before we can say that these are done. This should happen between now and the end of the first quarter. We also know that our fourth quarter will now include the adverse impact from the recent Health IT accounting change. We expect this change will reduce fourth quarter EBITDA by approximately $12 million from what we otherwise would have recorded. Additionally, interest rates dipped at the end of the quarter, just at the very end of the quarter. It's a minor point, but it will adversely affect the recorded values of certain discounted liabilities relative to our expectations. We expect the adverse impact to the interest rate decline to be approximately $7 million.
So this aggregate $19 million accounting hit and the uncertainty around the settlements that I just mentioned mean that there's still a fairly wide range of outcomes for the fourth quarter earnings. Achieving our current 2011 EBITDA outlook range of $1,175,000,000 to $1,275,000,000 will remain dependent on the recognition of these favorable reimbursement settlements. Second, we provided a high-level review of our outlook for 2012 with adjusted EBITDA in a range of $1,200,000,000 to $1,300,000,000. This outlook would have been higher had it not been for the recent change in Health IT accounting. That change will push $31 million out of 2012 and into subsequent years. And third, we reconfirmed our longer-term outlooks for 2013 and 2015. These outlooks were for $1,335,000,000 to $1,535,000,000 in 2013 and $1,750,000,000 to $2,250,000,000 in 2015. As a reminder, we first issued those outlooks to investors a year ago at the time of this conference.
Now as these outlooks represent impressive growth, I think it would be helpful to review the conservative nature of the assumptions that we adopted last year in building them, and note that the assumptions remain substantially unchanged today. We'll provide more detail on these assumptions during our call on February 28. But Slide 8 reviews some of these assumptions, so why don't we cover them?
For example, first, based on recent experience, we're now more optimistic about core volumes in 2015. We're maintaining the same low average annual growth rate of less than 1% that we assumed a year ago, but we're now starting with a higher base, reflecting stronger-than-assumed performance in 2011.
Turning to pricing, there's more pressure on pricing now than there was a year ago. And although we've gotten commercial price increases of 6% to 7% or better in the past few years, we're now assuming that our annual commercial pricing increases could slow to 4% to 5% by 2015. Given our assumptions on core volumes and pricing, we're retaining our prior assumption for aggregate revenue growth in the mid-single digits.
We also remain conservative on our cost assumptions. Even though we achieved $70 million in cost savings related to our Medicare Performance Initiative, or MPI, in 2011, and expect $80 million in MPI cost savings in 2012, our incremental annual cost savings from MPI are assumed to remain at $50 million in 2013 and beyond. And finally, our collection rates are assumed to revert only to their pre-recession levels, which do not fully reflect the increasingly effective collection techniques that are introduced by Conifer in the past few years. The point is that we have not stretched in making these key assumptions on future earnings growth. Our assumptions are just as conservative as they were before.
To put these assumptions in the near-term context of what we're seeing going into 2012, the aggregate admissions picture looks considerably stronger. Commercial admissions were modestly weaker than we assumed in the first half of 2011, but they exceeded our assumptions in the second half. To remain conservative, we continue to assume commercial admissions will decline through 2012.
Turning to cost, again our Medicare Performance Initiative has been hugely successful. And despite the emphasis on -- all the emphasis on Medicaid cuts, if you step back and assess the totality of government reimbursement, the aggregate picture is actually stronger than what we assumed last January. This improved picture is primarily the result of favorable provider fee developments, but it was also helped by Medicare reimbursement. Developments like the California Provider Fee extension for 30 months and the 1% increase in the Medicare market basket that we got in October were both significantly better than our prior assumption of no extension of the Medicare -- of the California Provider Fee and another 50 basis points Medicare cut, similar to what we saw in 2010.
The next 4 items represent where we are simply reconfirming the favorable views that we communicated last year. Commercial pricing continues to improve, consistent with last year's assumptions, although as I've just mentioned, we expect by 2015 that a 5% increase will be more difficult to achieve.
Conifer is achieving its performance milestones. We had some concerns about acuity trends over the summer, but by the end of the third quarter, these ended up being immaterial overall. And while bad debt trends continue to pressure current period profitability, our prospects are for improvement as the economy recovers.
The headwinds we see going into 2012 are the reductions in Medicaid reimbursement that I've already mentioned, payer mix pressures resulting from the more rapid growth in Medicaid volumes, and a decline in 2012 Health IT incentives relative to those that we recognized in 2011.
A key driver of our earnings growth has been an improving picture in patient volumes. As Slide 10 demonstrates, Tenet has achieved a remarkable turnaround in both inpatient and outpatient volume trends through the middle of 2009. At that point, the recession interrupted the growth trend and volume softened through the middle of 2010. Since mid-2010, the volume picture has turned once again and strengthened in 2011.
This chart is one of the favorite -- my favorites in our slide deck. For the last 8 years, we've generated uninterrupted growth in EBITDA that's averaging 16%. Since we acquired only 1 hospital and built only 4 new hospitals during this period, this is essentially entirely organic growth. The significance of this 8-year growth trend quickly becomes evident when Tenet's growth is contrasted to our investor-owned peer group, which is the graph shown on Slide 12. While Tenet's margins have more than doubled during this 8-year period, peer margins have actually eroded. And as a result, we've narrowed the margin gap from more than 1,000 basis points 8 years ago to just over 200 basis points in the 4 quarters ended in September.
Slide 13 provides a more granular view of our comparison to peers. The chart compares both EBITDA and admissions growth to our peers over the last 19 quarters. You can see the granular data, but the takeaway is that Tenet's admissions growth beat the peer average almost 2/3 of the time, and EBITDA growth outperformed the peers nearly 60% of these quarters. In thinking about these growth comparisons, it's really hard to justify the multiple discount that we have at our current share price.
Our track record of strong earnings growth helped by some debt retirements has also driven a remarkable improvement in Tenet's leverage ratio. As Slide 14 illustrates, Tenet is currently among the least levered companies within the investor-owned sector. Our leverage has been methodically reduced by both debt retirement and the growing earnings power that we've documented on the preceding slides. This relatively under-levered profile gives us important flexibility. We've used some of this flexibility in our share repurchase program that we announced last May. Through the end of October, we had repurchased 60 million shares, or slightly more than 12% of the total shares outstanding. We've continued to execute this program, and we'll provide a more current update on February 28.
Our balance sheet flexibility is also evident in our maturity profile. Over the last 3 years, we've taken advantage of market opportunities to significantly extend debt maturities. The first maturity of any size is in 2015, and now there are no -- and then there are no maturities after that until 2018, more than 6 years from now.
Slide 16 lists 7 drivers that we expect to fuel our earnings growth over the next few years. A year ago, we quantified the earnings contribution we expected from each of these drivers in our outlooks for both 2013 and 2015. We intend to update the contribution of each of these drivers to our expected earnings growth on our fourth quarter February 28 earnings call. And in the interim, let me offer a high-level update on our recent progress. We're building good momentum in our outpatient acquisitions. Since accelerating our aspirations for outpatient growth 2 years ago, we've completed 39 outpatient acquisitions. We started by focusing on imaging centers and then added surgery centers. We've built urgent care centers and freestanding emergency rooms, and we'll continue adding all of these types of outpatient centers as we go forward. Compared to hospitals, they offer a lower price point and greater patient convenience, and they act as channels to our physician partners and to our hospitals.
I've already mentioned our excitement about the Conifer business and our great performance in implementing the Medicare Performance Initiative cost efficiencies. Our Health IT initiative remains on track, and we still expect to earn $320 million in government incentive payments, although the new accounting method will defer some of the recognition.
Our performance on bad debt expense remains very well controlled. This is despite the pressures one would otherwise expect from a soft economy and the challenging unemployment rates in many of our markets. The opportunity to accelerate our earnings growth through the favorable dynamics of operating leverage remains very real. Our current capacity utilization is just in excess of 50%. The implication of this modest utilization is that we can handle significant volume growth before confronting meaningful capacity constraints.
And last, the Affordable Care Act is the law of the land, but the fact remains that this is 1 of only 7 drivers that we expect to contribute to earnings growth. We can expect considerable growth even in the absence of this important legislation.
Now I'm not going to spend much time on Slide 17, but we did want to provide some detail on the timing implications of the revised accounting for recognizing our Health IT incentive payments. We've provided this information in the past, so we felt it important to provide this revised detail once it became possible to quantify the implications of the accounting change.
So what should this mean for our equity evaluation? To review the highlights, for the last 8 years, we achieved uninterrupted growth in EBITDA with an average compound growth rate of 16%. In 2009 and in 2010, we beat guidance by an average of 15%. As we announced this morning, we expect to achieve our outlook for 2011 if we conclude certain settlements. If those items are delayed, they'll just simply contribute to a stronger 2012.
We have a $2.2 billion NOL, which helps with the efficient conversion of that EBITDA into cash flow. We've established a set of interrelated strategies with proven ability to drive growth in our business fundamentals. And we've gone to great lengths to provide transparent disclosure of our performance so investors can get a clear view of our valuation drivers. We're creating enhanced diversification of earning streams, including the important growing contribution from Conifer. And while some of our markets have been hard hit by the recession, our presence in the sunbelt is expected to create attractive long-term growth. Our track record, our proven growth strategies and the upside that we expect from both an improving economic cycle and from the Affordable Care Act should drive enhanced cash flow generation and favorable margin expansion.
So, John, thanks again for inviting us to the conference, and we'll now head to the break-out room down the hall for your questions. Thank you.
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