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There is currently a trend of consolidation afoot in the U.S. healthcare industry, as companies that are struggling in an adverse economic climate are being merged or acquired to create large cornerstones of the industry.

It would therefore be a reasonable assumption that Tenet Healthcare (NYSE:THC), which -- by its own admission -- has a 21% market share on average, would be in a strong position to counteract these negative market forces, especially considering strong share price performance growth since July of 34%. Tenet, however, is particularly susceptible to wider market conditions.

Taken at face value, Tenet also seems to be doing very well. According to its Q2 earnings forecast, it has increased revenues by 6.2%, with a 1.5% adjusted admissions increase. It has also performed better in terms of market share in comparison to the same time in 2011.

Exposure to Flagging Medicaid States

Tenet is very heavily exposed to the U.S. economy as it has no global operations. Furthermore, the states that it is most prevalent within in terms of beds (62.8%) are ones that have large state budget deficits (California,Texas, and Florida), which are likely to be clawed back in the form of Medicaid or related program cuts.

Currently, 9% of the company's revenues comes from Medicaid. The overall number of patients attributable to this class is likely to increase with additional jobless claimants and program eligibility. Yet, the revenues that they provide will rise disproportionately due to the complexity of reclaiming payments and the likely cuts to Medicaid funding. In summary, this means more patients providing less revenue.

A Dose of Federal-Flavored Uncertainty

The outlook is similar for the Federal Medicare program, which provides 25% of the revenues toward Tenet. Enrollees are likely to increase due to companies under a greater "fiscal cliff" tax burden cutting the amount of retirement healthcare schemes, forcing many retirees into a less profitable Medicare scheme (managed care schemes produce a 79% better yield, according to Tenet).

In addition to a rise in enrollment, as Medicare is federally backed there are a lot of cost-cutting pressures to be faced. For instance, the 2% cut to physician funding will further reduce the amount that over 700 physicians get to fund their Tenet-backed care, therefore impacting the bottom line of Tenet's income statement.

Accounting for Continued Success Is Doubtful

The main effect of this exposure is the doubtful accounts that this creates, accounting for $379 million in the first half of 2012 (out of $644 accounts payable, a 9.2% increase on second-half 2011 figures at 7.6% of revenues). This is especially true when considering the number of uninsured patients that Tenet takes in, as it has a great deal of exposure to the high uninsured rates in Texas (25%) and California (17%). Even with the intention of affordable healthcare for all, that is still likely to increase due to ineligibility for Medicaid/care and dwindling disposable income, with the impending fiscal cliff as an aggravator.

The Uninsured -- A Revenue Sieve

Uninsured patients account for 10% of revenues and only 27.8% of uninsured patients pay back in full, most paying in a time period over 180 days. The type of care that uninsured patients receive is most commonly through the emergency room (amounting to 60.5% of admissions overall), ensuring more costly procedures and a longer stay, which raises the premium payable.

Payback Period (% in days)

Care Type

% of RevenuesQ2

% Admissions'11

0-60

61-120

121-180

180+

Managed Care

56%

48%

75%

12%

5%

8%

Medicare

25%

30%

93%

3%

2%

2

Medicaid

9%

13%

64%

17%

9%

10%

Uninsured

10%

9%

31%

17%

10%

42%

Source: Tenet Healthcare 10-Q (Q2), 10-K (FY 2011).

Heavy Reliance on Debt Funding

The threat to Tenet's revenues is amplified when considering the amount of long-term debt that is held. As of Q2 2012, long term equaled $4.51 billion with a debt-to-equity ratio of 3.83. This is high for the industry, with only two other companies (HCA and CYN) registering higher (with relatively better financial health). This also represents a notable (16.8%) increase in debt levels from January 2011.

Click to enlarge image.

The main reasons behind Tenet's debt are I.T. contract extensions (five years for implementing EHR compliant infrastructure) and company expansion (including building and acquiring hospitals and general funding for budget shortfalls). This is not extraordinary; however, the ratio of debt funding for operations that is used by the company could alter significantly to offset a downturn in revenues.

The majority of debt that Tenet hold maturity dates past 2018, which ensures that the burden of interest payments will be felt for the foreseeable future without any significant changes to leverage levels. This interest expense had decreased in June 2011 to $59 million, yet has risen steadily to a level of $102 million in September 2012 -- in line with more debt taken on.

A Bleak Outlook That Is Likely to Dim Further

Diminished Medicaid/care revenues alongside the trend of increasing costs within the healthcare industry contribute to a greater amount of doubtful accounts payable. These accounts will cause uncertainty regarding cash flows, which will gradually increase as the economic conditions worsen in the U.S.

State budgets due in June 2013 may set out further constraints to revenue streams for Tenet, due to likely cuts on Medicaid expenditure and the knock-on effects this may have. The U.S. election in November is likely to change Medicare payments.

All the factors above may put Tenet in a position to suffer from financial distress. In fact, the boundaries of repaying senior debt could be pushed, thus making refinancing arrangements less favorable. This is why the company might become an increasingly favorable "short" target as the year progresses.

Source: 'Tenet-ative' Times For One Of The Largest U.S. Health Providers