OREANDA-NEWS. Fitch Ratings has affirmed Tenet Healthcare Corp.'s (Tenet) ratings, including the long-term Issuer Default Rating (IDR) at 'B'. A complete list of ratings follows at the end of this release. The ratings apply to approximately $14.8 billion of debt at Dec. 31, 2015. The Rating Outlook is revised to Stable from Negative.

KEY RATING DRIVERS

-- Tenet's ratings are constrained by the company's high leverage and weak cash generation; progress in reducing leverage since the acquisitions of Vanguard Health Systems (Vanguard) and 50.1% ownership of United Surgical Partners International (USPI) has been slow.

-- Although Tenet's recent acquisitions have stressed the balance sheet, Fitch views the transactions as strategically sound because of secular shifts favoring larger, integrated systems of care delivery.

-- Tenet's free cash flow (FCF) and operating margins are weak compared to some hospital industry peers, but 2015 levels were better, and Fitch expects improving underlying business fundamentals and lower project-related capital expenditures to drive continued improvement in 2016-2018.

-- Aside from Tenet's weak cash generation, there are no major concerns with the company's liquidity profile; the next significant debt maturity occurs in 2018 and the debt agreements do not require compliance with financial maintenance covenants except in limited circumstances.

Tenet is among the largest for-profit operators of acute care hospitals in the U.S., and following the acquisition of a majority ownership interest in USPI in 2015, the largest operator of ambulatory surgery and imaging centers. Scale is increasingly important as U.S. healthcare providers seek efficiencies to offset the effects of an overall constrained reimbursement environment. USPI improves Tenet's payor mix and markedly boosts the company's position in more profitable outpatient services. The USPI business also provides Tenet with an offset to Fitch's expectation for very slow growth in inpatient hospital volumes due to a secular shift toward lower-cost care delivery settings.

Debt funding of the USPI joint venture (JV) added $2.4 billion of debt to the capital structure and prolonged the de-leveraging horizon Fitch had considered following Tenet's 2013 acquisition of Vanguard, which left the company with one of the most highly leveraged balance sheets in the for-profit hospital industry. Leverage stood at 6.3x at Dec. 31, 2015 (before deduction of income attributable to non-controlling interests and 7.0x after), versus 4.4x prior to the Vanguard acquisition.

Fitch does expect the company to reduce leverage over the next two-to-three years, but progress will be slow, since it relies primarily on EBITDA growth. Tenet's weak FCF limits the company's ability to repay debt; about $1 billion in cash proceeds from recent asset sales provide a debt reduction opportunity, but we believe some of this cash will be used to fund other capital deployment priorities, including purchase of the remaining equity interest in the USPI JV.

Tenet's limited financial flexibility, most particularly its negative FCF (CFO less capital expenditures, cash distributions to minority interests and certain non-recurring items) generation, has been the major issue constraining the company's ratings over the past several years. The rate of cash burn has been incrementally improving due to expansion of operating margins and the refinancing of high-cost debt, and starting in 2017, lower capital expenditures will also be a tailwind as large in-progress projects are completed. In 2015, Tenet produced positive FCF of $78 million. Fitch expects Tenet to generate positive but thin FCF throughout the forecast period in the ratings case, with an FCF margin of about 1%.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Tenet include:

--Top-line organic growth of about 5% annually in 2016-2019. This assumes low-single-digit growth in Tenet's Hospital Operations segment and mid-single-digit growth in the Conifer Health Solutions and Ambulatory Care segments;

--Operating EBITDA (including income from affiliates and before deduction of income attributable to non-controlling interests) of $2.4 billion in 2016 with an operating EBITDA margin of 12.8%; the margin is expected to expand slightly through 2019;

--Tenet will spend $1.5 billion of cash to acquire the remaining 49.9% interest in the USPI JV through 2020;

--Capital expenditures of $850 million in 2016, declining to about $775 million in 2017;

-- Cash distributions to minority interests of $230 million-$250 million annually in 2016-2018;

-- FCF (CFO less capital expenditures, cash distributions to minority interests and certain non-recurring items) is consistently positive, and the 2016-2019 FCF margin is about 1%;

--No substantial change in debt balances in 2016-2019;

--Gross debt/ EBITDA before deduction of income attributable to non-controlling interests (NCI) declines to 5.2x by 2019.

RATING SENSITIVITIES

Negative Rating Sensitivities:

The 'B' IDR considers gross debt/EBITDA before deduction of NCI dropping to below 5.5x (and to about 6.0x after deduction of NCI) over the next several years as a result of growth in EBITDA. Maintenance of the rating also considers that Tenet will make continued slow progress in expanding operating and FCF margins. A reversal in positive trends could result in a negative rating action, particularly if coupled with capital deployment that requires additional debt funding. Specifically, gross debt/EBITDA before deduction of NCI sustained above 6.5x and a cash flow deficit that requires incremental debt funding are likely to cause a downgrade to 'B-'.

Positive Rating Sensitivities:

An expectation of gross debt/EBITDA before deduction of NCI sustained near 5.0x and a FCF margin of 3%-4% could result in an upgrade to 'B+'. This is unlikely over the next several years given Tenet's weak FCF and high leverage.

LIQUIDITY

Tenet's liquidity profile is adequate aside from persistently weak FCF. At Dec. 31, 2015, liquidity was provided by $356 million of cash on hand and $995 million of availability on the $1 billion capacity bank revolver with LTM FCF of $78 million, there are no significant debt maturities until 2018, and compliance with financial maintenance covenants is not a concern. LTM EBITDA/gross interest expense equals 2.7x.

Tenet's debt agreements do not include financial maintenance covenants aside from a 2.0x fixed charge coverage ratio test in the bank agreement that is only in effect during a liquidity event, which is whenever available credit as calculated based on the bank agreement definitions is less than $80 million. The senior secured note indentures do limit the company's ability to issue additional secured debt, which is permitted up to the greater of $3.2 billion and 4.0x EBITDA. Debt secured on a pari passu basis to the secured notes is limited to the greater of $2.6 billion and 3.0x EBITDA. Tenet has about $3.5 billion of incremental total secured debt capacity and $1.1 million in pari passu secured debt capacity at Dec. 31, 2015, based on EBITDA as defined in the debt agreements.

FULL LIST OF RATING ACTIONS

Fitch has affirmed Tenet's ratings as follows:

--Long-term IDR at 'B';
--Senior secured ABL facility at 'BB/RR1';
--Senior secured notes at 'BB/RR1';
--Senior unsecured notes at 'B-/RR5'.

The Rating Outlook is Stable.

The 'BB/RR1' rating for Tenet's secured debt (which includes the bank credit facility and the senior secured notes) reflects Fitch's expectation of 100% recovery for the bank facility and 97% recovery for the secured notes under a bankruptcy scenario. The 'B-/RR5' rating on the senior unsecured notes reflects Fitch's expectations of recovery of 29% of outstanding principal. The bank facility is assumed to be fully recovered before the secured notes. The bank facility is secured by a first-priority lien on the patient accounts receivable of all of the borrower's wholly owned hospital subsidiaries, while the secured notes are secured by the capital stock of the operating subsidiaries, making the notes structurally subordinate to the bank facility with respect to the accounts receivable collateral.

Fitch's estimates an enterprise value (EV) on a going concern basis of $8.7 billion for Tenet, net of a standard deduction of 10% for administrative claims. The EV assumption is based on a 35% haircut to LTM EBITDA after the deduction of NCI. Fitch then applies a 7.0x multiple based on observation of both recent transactions/takeout and public market multiples in the healthcare industry.

Fitch assumes that Tenet would draw $500 million or 50% of the available capacity on the $1 billion revolver in a bankruptcy scenario, and includes that amount in the claims waterfall. The revolver is collateralized by patient accounts receivable, and Fitch assumes a reduction in the borrowing base in a distressed scenario, limiting the amount Tenet can draw on the facility.

Based on the definitions of the secured debt agreements, Fitch believes that the group of operating subsidiaries that guarantee the secured debt likely excludes any non-wholly owned and non-domestic subsidiaries, and therefore does not encompass most of the value of the Conifer and Ambulatory Care segments. At Dec. 31, 2015, about 73% of consolidated EBITDA was contributed by the Hospital Operations segment, and Fitch uses this value as a proxy to determine the rough value of the secured debt collateral, which is assumed to be $6.4 billion. Fitch assumes this amount is recovered by the secured holders, leaving $2.4 billion of non-collateral value to be distributed to the unsecured claimants. Based on $6.6 billion of total secured claims (which included the ABL facility and senior secured notes), the resulting first-lien secured deficiency claim of $282 million is added to $7.8 billion of senior unsecured claims, resulting in $8.1 billion of total unsecured claims.