Inside Wall Street: Tenet Healthcare's Recent Tumble Could Be an Opening

Gene Marcial's Inside Wall Street
Gene Marcial's Inside Wall Street

In these volatile times, shares of Tenet Healthcare (THC) have been behaving as wildly as the VIX volatility index itself, seesawing frenziedly in the past week. On Tuesday, June 1, Tenet jolted investors when its stock plunged 17%, to $4.72 a share, but swiftly rebounded the next day, to $5.09, only to sink once again, to $4.92 on Friday, Jun. 4. That's quite slump from its 52-week high of $6.46 on Mar. 23, 2010.

Buyout talks are behind the stock's sharp swings. Tenet, the third-largest publicly held U.S. hospital chain, which owns and operates 50 acute-care hospitals, is in preliminary discussions to buy Healthscope, the second-largest hospital company in Australia. It owns 43 hospitals, or 15% of Australia's private-hospital market. One problem for Tenet is that several of its large shareholders are adamantly opposed to the idea, in part because they fear it would dilute earnings and the value of its stock. .

That might prove true for the short term. But for investors who don't yet own the stock, this may be the rare chance to step in -- when the share price is pulling back. Several savvy buyout pros believe the stock's drop is a compelling buying opportunity, with or without the acquisition of Healthscope. Tenet, whose market cap is $2.6 billion, generated sales of $9 billion in 2009, and in 2010, analysts expect revenues of $9.3 billion and to rise further to $9.7 billion in 2011.

Split Decision on the Deal

It's far from certain that a deal would be consummated, but Tenet says acquiring Healthscope would enhance its margins and growth rates, and would also advance Tenet's position as a leading global hospital operator. Nonetheless, at least one large Tenet shareholder expects pressure from stockholders will force the company to withdraw from the buyout talks.

Wall Street is split over the deal's benefits. Nine of the analysts tracking Tenet are bullish, and 11 are neutral. One recommends selling the stock.

One analyst who upgraded the stock when Tenet confirmed that it had been talking with Healthscope -- and caused the stock to bounce up on Jun. 2 -- is A.J. Rice of Susquehanna Financial Group. He raised his rating on Tenet to positive from neutral and pegged his 12-month target for the stock at $6.50 a share.

Rice believes acquiring Healthscope would be 30% accretive to his 2011 earnings forecast of 26 cents a share. He figures that in 2010, Tenet will earn 22 cents, up from 2009's 16 cents. This level of accretion is before taking into account any cost savings that may be derived from the deal, says Rice. And he figures that even if the buyout were to be 100% financed by borrowing, Tenet's debt-to-EBITDA ratio would only approximate 4.8, a level that the analyst notes would be comparable to those of its peers.

A Modest Increase of Expectations?

As positive as the acquisition may be, Rice believes there's at least a 50% chance that a deal won't materialize, which he expects would lead Tenet to refocus on its domestic turnaround efforts. Healthscope isn't lacking for bidders. A consortium of Texas private equity groups, including Pacific Group, Carlyle Group and Blackstone Group, has offered to buy Healthscope for $5.80 a share, or about $2 billion. If Tenet walks away or doesn't win in the bidding, the risk-reward ratio from its currently depressed stock becomes even more compelling, says Rice.

Based on fundamentals alone, Tenet is attractive as its current improving sales volume, and operating trends are on track. So, Rice expects management will modestly increase its expectations for 2010 when it reports second-quarter results in the next few weeks.

Concerns that an acquisition of Healthscope may be dilutive to Tenet's earnings may not be valid, according to some. "Our initial analysis using consensus forecasts for Healthscope's fiscal 2011 results indicates only a modest plus or minus 5% impact on projected 2011 earnings per share," says B. Kemp Dolliver, managing director at Avondale Partners, who rates Tenet as outperform, with a 12-month price target of $9.

The Australian health care system has several appealing features, says Dolliver, For one thing, the government encourages private sector health insurance, he notes, and the industry is financed with both private and public funds.

A Significant and Cheap Health Care Play

Dolliver says he's riding out the stock's downdraft, which is already discounting the impact of a possible acquisition. The stock is now inexpensive, Dolliver figures, because it's trading at 5.7 times 2010 estimated EBITDA, which is below the sector's average of 6.5 times. Healthscope's 43 hospitals would add to Tenet's revenues of $1.8 billion and 13.7% EBITDA margins.

The bottom line: The stock would be a significant and cheap health care play for investors, with a lot of prospective growth for Tenet in the global market.