FatCamera
Shares of Tenet Healthcare (NYSE:THC) have seen some momentum again, as the business recently has sold off some of its facilities. These sales and operating momentum pleased investors, who are furthermore relieved to see interest rates come down (as Tenet employs quite some leverage).
While I recognize these green shoots, I see that the past of Tenet is quite turbulent as well, as an asset-heavy, higher debt and low-margin business is not necessarily a great investment proposition for a long term investors. I see no reason to get involved here at current levels, even as numbers suggest a non-demanding and fair valuation.
On Tenet
Founded in 1969, Tenet describes itself as a diversified healthcare service company. Its care delivery segment is called United Surgical Partners, the largest ambulatory platform, with full ownership or an interest in some 480 ambulatory surgery centers and hospitals, complemented by acute care and specialty hospitals.
About three quarters of revenues are generated from the hospital segment, nearly a fifth from the very lucrative ambulatory segment, complemented by a smaller yet lucrative conifer segment as well.
The growth and consolidation of the hospital system has been a trend which goes back way before 2000, yet shares and the company took a huge beating in 2002 amidst a big scandal around billing practices. The impact was large, as a debt-loaded business saw a $200 stock in 2002 fall to just $4 per share in 2009.
With the passage of time and bolt-on dealmaking, the company grew sales from $11 billion to roughly $20 billion over the past decade, as high single digit operating margins have risen to around 13-14% of sales more recently. A combination of organic growth but certainly dealmaking were the drivers behind the results, as the company has built up quite a substantial net debt load.
The Numbers
Early in 2023, Tenet posted a 1.6% decline in full year sales to $19.2 billion and while a $3.5 billion EBITDA number looks strong and high, the business is asset heavy as it holds so many properties. Operating profits of $2.3 billion worked down to margins of 12% and change, on which GAAP profits of $1.0 billion were reported.
Due to the fact that the company is just a partial owner of many properties, it were GAAP profits which came in at $411 million, equal to $3.84 per shares as that number was more than cut in half from the year before. The minority interest is very large, as net income to noncontrolling interests sometimes even exceeds net income to investors in Tenet itself.
The reported results were a bit too shortsighted as well, as 2022 results included a $1.66 per share restructuring charge, while the 2021 resulted benefited from a gain on asset divestment, as adjusted for these the trends look a lot more stable.
On a total balance sheet of more than $27 billion, the company employed $14.2 billion in net debt, leaving the company quite leveraged and susceptible to higher interest rates.
The company guided for flattish results in 2023, seeing sales at midpoint of $19.9 billion, with adjusted earnings seen around $5.30 per share. By October of last year, the company had raised the full year guidance to $20.4 billion in sales, with adjusted earnings seen around $5.70 per share, all while net debt ticked down slightly to $14.0 billion, with full year EBITDA seen around $3.4 billion, translating into a 4 times leverage ratio.
Becoming Smaller, Reducing Leverage
After announcing the deal in November, the company closed on the sale of three hospitals in South Carolina to Novant Healthcare, in a $2.4 billion deal set to yield after-tax proceeds of $1.75 billion.
Combined, these hospitals generate $552 million in sales, $150 million in EBITDA and $126 million in operating income, indicating that these businesses are relative asset-light and very profitable, with margins posted in excess of 20%. Net proceeds amount to over 3 times sales, driven by the strong margin profile.
The company furthermore announced another deal with UCI Health to sell 4 hospitals in Orange County and LA in a $975 million deal, yielding post-tax proceeds of $800 million. Generating a billion in sales, these hospitals generated $71 million in EBITDA and $29 million in operating income, as these activities are valued below 1 times sales.
Total post-tax proceeds of $2.55 billion will make a meaningful dent in overall leverage, pushing net debt down to $11.5 billion. At the same time, some $200 million in EBITDA will leave the door, reducing pro forma leverage from just over 4 times to about 3.6 times EBITDA.
On top of these deals, the company pre-announced that 2023 results will top the previous outlook provided.
Deleveraging, Applauded By The Market
An $89 stock at this moment of writing, saw shares rise some $6 in response to the latest news flow, as the move now values stock of the company at $9.4 billion based on 104 million shares outstanding. Including the prevailing net debt load of $14 billion, the company is valued at just over $23 billion, or just over 1 times sales of $20 billion (of course, all ahead of recent divestments).
Two recent divestments, for combined after-tax proceed of $2.55 billion, make up for just over 10% of the value, but they will involve just $1.5 billion (about 7-8% of sales) leaving the door. Nonetheless, a $200 million EBITDA number reveals that a 12-13 times multiple has been fetched.
That suggests that the company has seen very nice multiples for its divested activities, but on the other hand, the divested activities are a bit less asset-rich, with a higher operating income to EBITDA ratio.
What Now?
Quite frankly, I lack conviction, as I do not think that the risk-reward of investors in this space is particularly nice. $5-$6 earnings per share power works down to a fair multiple. At the same time we have to recognize that long term investors do not really benefit from a sustained net buyback program (over time), do not receive a dividend, as shares have displayed huge volatility in the past.
While the recent divestments look nice on a relative basis, they indicate the great diversity between the quality and profitability of assets as well, as the picture is a bit more troubled because of large minority interests. These drive up EBITDA numbers, but result in a poor net profit to EBITDA ratio.
While the latest divestment looks relatively good, I recognize that shares have seen a huge run already since the fall, as I feel no need to get involved here.
