Fitch Affirms Tenet Healthcare on USPI Transaction; Revises Outlook to Negative

Fitch Ratings has affirmed the ratings of Tenet Healthcare Corp. (Tenet; NYSE: THC), including the 'B' long-term Issuer Default Rating (IDR). The Rating Outlook is revised to Negative from Stable.

A full list of rating actions, which apply to approximately $13.8 billion of debt at Dec. 31, 2014, follows at the end of this release.

The rating actions follow Tenet's announcement that it will raise approximately $2.4 billion of new long-term debt, including $500 million of senior secured notes and $1.9 billion of senior unsecured notes, to fund a transaction with private equity firm Welsh, Carson, Anderson & Stowe (Welsh Carson). The deal will combine Tenet's ambulatory surgery and imaging centers with those of Welsh Carson-owned United Surgical Partners International (USPI) to create a joint venture (JV) majority-owned (50.1%) by Tenet.

Tenet will also acquire Aspen Healthcare Ltd. (Aspen), an operator of private hospitals and clinics in the U.K., from Welsh Carson. Tenet expects both transactions to close by the third quarter of 2015.

KEY RATING DRIVERS

--Tenet is among the largest for-profit operators of acute care hospitals in the U.S. and, through its USPI JV, will become the largest operator of ambulatory surgery and imaging centers. Such scale is increasingly important among U.S. healthcare providers in order to drive efficiencies that offset the effects of an overall constrained reimbursement environment.

--Incremental debt expected to fund the transaction will prolong the de-leveraging horizon Fitch has considered following the 2013 acquisition of Vanguard Health Systems, Inc. (Vanguard). Opportunities to repay debt are limited over the ratings horizon given the absence of prepayable debt in the pro forma capital structure.

--The structure of the USPI transaction is unfavorable to Tenet's balance sheet initially. Funding will occur at the parent company level rather than at the JV level, which will dilute the free cash flow (FCF) benefit to Tenet. Furthermore, Fitch expects USPI will use a large portion of its FCF to fund strategic M&A, supporting EBITDA growth and contributing to de-leveraging over time.

--The USPI deal is strategically compelling. It will improve Tenet's overall diversification and payor mix, markedly boost Tenet's somewhat laggard position in outpatient services, and add to growth potential going forward. The USPI business will also provide Tenet with an offset to Fitch's expectation for flat to declining inpatient volumes due to a volumes shift toward lower-cost settings.

--Fitch expects improving underlying business fundamentals, particularly at legacy Vanguard, to combine with lower uncompensated care from the coverage expansion components of the Affordable Care Act to drive improving FCF generation in 2015-2016.

--Hospital industry management teams are contending with a very dynamic operating environment due to the implementation of the ACA, the evolution of payment schemes, and other regulatory reforms influencing organic operating trends. Tenet is now adding the complex partnership-driven business model of USPI on top of the ongoing integration of Vanguard, which was Tenet's largest major acquisition in recent history and included a large schedule of in-progress and recently completed capital expansion projects.

RATING SENSITIVITIES

Maintenance of Tenet's current 'B' IDR considers gross debt/EBITDA trending toward 5.5x over the next one to two years. De-leveraging is expected only from EBITDA growth, as Tenet will not have a material amount of prepayable debt post-deal.

Debt leverage of 5.9x at Dec. 31, 2014 remains elevated from the 2013 acquisition of Vanguard Health Systems, Inc. (Vanguard) and will be pushed even higher by the transaction. Fitch estimates pro forma gross debt/EBITDA of 6.5x, but acknowledges this figure gives Tenet full credit for the USPI business, which it will initially only half own. Additionally, the structure of the USPI transaction limits the near-term FCF accretion to Tenet because the company is funding the transaction on its own balance sheet rather than at the JV level.

Nevertheless, Fitch expects growth- and synergy-driven de-leveraging post-deal and may consider raising the 5.5x gross debt/EBITDA target as Tenet's growing share of the JV's cash flows (growing with Tenet's increasing ownership) add to Fitch's expectations for materially improved core FCF generation in 2015-2016.

The Negative Rating Outlook illustrates that a downgrade could result if Fitch does not expect Tenet's cash generation to be sufficient to fund the bulk of cash outflows associated with future acquisitions, both of remaining USPI interests from Welsh Carson and otherwise. Fitch estimates run-rate FCF at legacy Tenet will need to trend near $300 million by 2016 in order to avoid incremental associated debt financing.

A positive rating action is unlikely over the next one to two years given Tenet's constrained FCF and weak margins. Furthermore, the 'B' IDR incorporates the expectation for generally improving operations in the hospital industry due to the ACA and economic improvement in the near term.

KEY ASSUMPTIONS

--Underlying acute care business growth in the low- to mid-single digits, mostly driven by commercial payor pricing increases with relatively flat volumes, ex-ACA;
--Robust inorganic growth opportunities for the USPI JV, boosting an otherwise good organic growth outlook possibly into the low-double digits;
--No debt repayment in 2015-2017 except the refinancing of revolver balances;
--Tenet and Welsh Carson will exercise put/call options in order that Tenet owns 100% of USPI by 2020;
--Capital expenditures of $1 billion or more in 2015 and 2016.

Fitch has affirmed the ratings of Tenet as follows:

--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 Negative.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

-- 'Corporate Rating Methodology' (May 28, 2014);
-- 'Tenet Healthcare Corp. - Ratings Navigator' (Feb. 20, 2015);
-- 'U.S. Healthcare Providers: Ratings Navigator Companion' (Feb. 17, 2015);
-- 'Hospitals Credit Diagnosis: Favorable Factors Converge to Support Organic Growth' (Jan. 5, 2015);
-- 'Fitch Rates Tenet's Senior Unsecured Notes 'B-/RR5' & Affirms IDR at 'B'; Stable Outlook' (Sept. 24, 2014).

Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Tenet Healthcare Corp. - Ratings Navigator
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=862146
U.S. Healthcare Providers: Ratings Navigator Companion
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=812508
Hospitals Credit Diagnosis (Favorable Factors Converge to Support Organic Growth)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=845469

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981842
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.