Tenet Healthcare Corporation (THC) Earnings Call Transcript & Summary

Hi, everyone. I'm A.J. Rice, the health care services analyst at Credit Suisse. We're very pleased to have up next presenting at our conference, Tenet Healthcare. For Tenet, we have Executive Chairman, Ron Rittenmeyer; Saum Sutaria, CEO and Director; Dan Cancelmi, Chief Financial Officer and Executive Vice President; we've got Brett Brodnax, President and Chief Executive Officer of USPI, the company's ambulatory surgery business; and then Regina Nethery, Vice President of Investor Relations. I'm going to turn it over to Saum to make some initial comments. The company was good enough to announce a nice transaction last night that makes our presentation very timely. [Operator Instructions] But first, let me turn it over to Saum to make some initial comments, I think, particularly about this transaction last night.

Thanks, A.J. We're happy to be here and happy to have this chance to talk about the transaction and its impact on our portfolio. I'll be brief because I know you do have a number of questions that you've either collected or coming in still. But let me just provide a brief summary to simplify what we announced last night and also put it in a little bit of context about what we've been trying to achieve during the pandemic. So if you recall, December, roughly a year ago, we announced a transaction for the acquisition of about 45 centers from SCD. Those were centers that were generally more mature. We then added 4 more early in the new year to make a total of 49. But that initial 45, we had described had at first year, rough kind of initial EBITDA of $130 million in EBITDA minus NCI. And what we said at that time was that based upon USPI's operating model and ability to deliver synergies, we would bring that effective multiple that those assets were acquired at right below 7, which if you do the math, you'd generally think about it as roughly generating $160 million or so in EBITDA minus NCI once they were ramped up. Now yesterday's transaction, we noted that there are 92 centers that are in the initial acquisition pool before this development agreement, which I'll describe. 65 of those centers, one can think of is very similar to the 49 that we had acquired before. And then there -- sorry, 65 of those centers. And then 27 are still in early stages of start-up, basically. Interestingly, in the first year, we still project from these new centers, about $130 million in EBITDA minus NCI. And by the end of year 3, again, getting to a low 7 multiple, which we presented yesterday. And at the midpoint, that portfolio, we think, will generate about $205 million in EBITDA minus NCI, again, after USPI's ability to deliver synergies mature in that portfolio over time. So we're very excited about the growth potential of those facilities, even greater than what we saw in the first and separate transaction that we did a year ago. We are also confident in our ability to perform and execute on the buy-ups that we talked about yesterday. In fact, Brett and the team in that first tranche and the first transaction of 49 centers successfully ended up completing buy-ups in all of the centers. And given the attractive management and other service offerings that USPI can provide, we're confident in our ability to work with SCD and importantly, work with these physicians to execute on those buy-ups. And again, I think importantly, that will drive the multiple back into a similar range as we saw with the first and initial transaction. The ability to acquire assets like this, high-quality assets, high-margin assets with superb doctors and drive that multiple down in the low 7s, especially when assets like this trade at almost 50% to 100% premium to that in the marketplace from a multiple standpoint, we believe, is significantly value accretive for Tenet's shareholders. If you think about this transformation of USPI over the last couple of years, let me just put it in context. I mean, at the end of 2019, USPI had about 285 centers in the surgery business, with roughly $550 million in EBITDA minus NCI, margins were about 40%. These 2 deals, separate deals, add about 140 centers, what we project to be about $365 million in EBITDA minus NCI when ramped up, which means USPI will be about 2/3 larger than it was right before the pandemic relative to what we're poised to do with this portfolio today. And we think the margins will actually go up from about 40% and creep up a little bit higher in the low 40s range. The other thing that's really nice about this is that in a business like ambulatory surgery, where the typical maintenance and technology capital is about $1 in $10, maybe $1 in $8 at the most of EBITDA generated, the cash flow profile ought to be very, very attractive. If you think about the other thing we did during this pandemic period from a transformative standpoint, we divested the Miami-Dade market, 5 hospitals we had there while maintaining the ambulatory surgery portfolio still within USPI, generated over $1.1 billion in proceeds. EBITDA minus NCI on a starting basis was actually lower than what we acquired in this portfolio, had a lower growth rate, margins that were less than 15% prior to overhead. And that kind of portfolio requires 1 in every $3 and up to 1 in every $2 of EBITDA generated in CapEx. So the repositioning and the strategic reallocation of capital that we committed to a few years ago in Tenet's business is also beneficial in our view, an estimation to our shareholders. And we're committed to this pathway looking forward. I think importantly, as Dan pointed out, leverage has improved significantly over the past few years. And this last transaction will be essentially leverage neutral for the company. So that's the transaction, and the portfolio change in the last couple of years, put into context. The other thing I would say is just we ought to look ahead. I mean, this SCD partnership, which might sound a little bit complicated on the face of it, is a tremendous accelerant for growth within the USPI platform. USPI is obviously -- it's been the fastest-growing engine in this space for years, leading the way in the industry and adding a complementary development arm in an exclusive relationship with SCD to target about 10 centers per year at a minimum in addition to the 15 to 20 that USPI typically delivers in a normal year. We see a pathway to adding another 125 to 150 facilities beyond what I described over this period of time. It really positions Tenet, looking forward, to be much more of a growth business. We'll probably get to our target of 50% of the EBITDA coming from USPI, not inclusive of Conifer ahead of plan, and even push past that perhaps over the next few years. So looking forward, we're very excited about this business mix. We're very excited about the complementarity between the 2 care delivery businesses, especially in putting forward a value-based proposition to all the payers in the marketplace with this continuum of care. So A.J., I'll stop there. I appreciate the opportunity to give that summary, and we're obviously all happy to take questions.

Okay. Just maybe sticking on this transaction for a minute. So your -- these deals with SCD, it seems like it's more than just the top price paid. Can you describe a little bit -- I mean do the physicians say that our partners in these surgery centers say, hey, we're comfortable with USPI's operating model. We're going to be part of that going forward, do they have influence on it? Is it -- what other aspects of it? Because it seems like the transaction itself, you might have got it at a somewhat better price than you would have got it if you just went to a standard auction and everyone was bidding on. Can you give us a little more flavor for that?

Yes, A.J., this is Brett. You're right. This is much more than just a transaction. It is actually our ability to buy a portfolio of assets that are mature, but as importantly, create a relationship, a partnership with the SCD principals that takes us through the next 5 years. And to Saum's point, our development engine will continue, as it always has, to develop 15 to 20 centers a year, perhaps more. And SCD's will run in parallel to that. But at the end of the day, the portfolios or the transactions that SCD does on their side of the equation and the development engine, on the USPI side, those facilities will come together into the USPI portfolio, again, over the next 5 years, kind of aggregate together over that period of time.

Okay. When you think about that development portfolio, it's an interesting aspect of the transaction, are you getting input on where they're looking to add those properties? Or do they go out and find the ones that they think are preferable and just do them on their own? And are you giving them a heads-up and the types of -- the 15 to 20 that you're going to do with them? How is that development activity being coordinated?

Yes. Well, we'll definitely collaborate. But as I mentioned on the call yesterday, they've been very successful with their own development criteria, their own development engine, how they source their transactions and their partnerships with their doctors. We have a little bit different model. So I think the best way to think about this is USPI and SCD historically have not overlap that much in terms of where we develop assets. In fact, we mostly acquire assets. We obviously have a significant number of de novos we do. They're almost exclusively de novo. So there's not a whole lot of overlap in terms of our development engines. So it's not like we're going to be cannibalizing their opportunities or they're going to be cannibalizing our opportunities. We essentially pursue different types of transactions and different physician groups. So it's very complementary in terms of our 2 development engines in terms of how they produce results.

Okay. And when you -- when it comes time for you to buy one of these ventures that they've put in place or one of these ASCs, is the pricing structure predetermined? Or will each deal be negotiated on its own basis?

Yes, there is a -- basically a fair market value -- valuation methodology that's built into the development agreement for every center.

Okay. And do we think about this as if they do, they're going to target roughly 10 because that's what they've done historically? You get a first look at all 10 of those, you're obligated to buy a certain percentage of those? What if they do 15 or 20, how does that change? Or does it change the dynamic in any given year?

Yes. They have historically actually done a few more than 10 a year. So we're trying to be conservative in terms of what they plan to do going forward. And you're right, we have the first option, actually, the exclusive option to participate in every single facility they do, whether it's 5 a year, 10 a year, 15 a year. So we'll have the opportunity to invest side-by-side with them at the initiation of the deal, the syndication of the deal. And then 18 months after the center is up and going, we have the ability to buy the SCD partners out at that fair market valuation methodology. And at that point, we'll also be making an offer to the doctors to purchase a percentage of their ownership, a minority percent of their ownership is typically about 1/3 of what they own to get to that controlling position.

Okay. Okay. And you have the right to choose not to participate? It sounds like you have a bias to participating. But if there happen to be deals that you didn't like, you're not obligated to participate in those?

That's correct, A.J.

Okay. I appreciate the comments about the $250 million that's going to go to buying out the physicians in place and the success you have with the first round of properties that you bought last year. Is that the primary basis? Is there any other reason to -- I mean, I think you said that 80% of the properties you expect to be in a point where you're consolidating. Is the primary basis for that confidence that you -- what your experience with the first round of assets? Or is there anything else about this? Do they have a number of physicians that are at retirement age, and therefore, they're looking to cash out? Is that part of what's going on here? Any color on that, let us know.

Yes. Well, I'll answer your first -- or your last question first. Related to retirement, it's -- the portfolio of physicians that they brought into their deals historically have been relatively young. And the overall average age of the physicians in this portfolio is relatively young as well. So we don't anticipate, we haven't seen any significant retirements from the [ DeLorean ] transaction. We certainly don't anticipate that here either. So again, we're confident that we'll have the ability to buy up. And primarily because we were so successful in the DeLorean transaction, as Saum mentioned, there are 49 centers and we bought up in all of them. So we're hopefully being conservative with the 80% that we've modeled in our numbers to get to the financials that you've seen in the deck from yesterday.

Right. And when these originally are set up as joint ventures with the physicians, I assume there's language in there about an exit price. So is the price at which they're going to sell to you already pretty much predetermined if they choose to accept it? Or is that negotiated facility by facility?

It will be fair market value, and it will be the same. We're going to offer the same purchase price multiple and valuation methodology for every single center. So it will be consistent, not center by center.

And with your experience with the first ones you bought -- or announced last December and closed in February, have you had much physician attrition out of there? Or is it about what you expected? Or have you had to bring in a significant number of new partners? How has that played out?

Yes. No, no, A.J., not a significant amount of attrition at all. We have added some new physicians to these partnerships, which is part of the value proposition of having USPI as a partner, and that's obviously a focus of us, for ours, is identifying new physicians that we can add to these facilities over time. And we plan to do that with DeLorean, the DeLorean first SCD transaction going forward, and we'll do the same for this SCD transaction.

I think, Dan, you had mentioned yesterday, I believe you were the one in the prepared remarks about the deal that it would be 16% accretive. I wanted to just make sure I had the building blocks for that. I don't know if you could walk through what the puts and takes are to get to that level of accretion. Are you -- would it generally range of financing costs and so forth that you're assuming?

A.J., yes, let me walk through that. Obviously, we're very pleased with the transaction and what we think the attractive returns are going to be from the transaction. We put out some markers for the end of year 1 in terms of the EBITDA numbers, the EBITDA minus NCI and then the EPS accretion. In terms of the financing, we're assuming that it will be first lien secured financing. We'll launch that this month and in all likelihood, close this month, obviously, depending on market conditions. In terms of the interest rate, I think if you looked at some of our tranches and see where they're trading, the interest rate's probably 4.25%, 4% type of range at this point, plus or minus. So we'll obviously -- we think it makes sense to finance this transaction. We've received a number of questions in terms of our available cash on the balance sheet, maybe should you guys just finance it through your balance sheet cash. And just as a reminder, we have a little over $1 billion of Medicare advances and deferred payroll taxes that we'll be paying back through the end of this year and through next September. So we took that into consideration. And also, we took into consideration, we have a couple of higher interest rate tranches that we can efficiently either refinance or retire next year. Two tranches in particular, second lien, 6.25% notes, $1.5 billion of notes. In February, they can be retired fairly efficiently. And then we also have $700 million of 7.5% notes that we can call next April. So pretty higher rate debt that we're targeting. And so we thought it was prudent at this time given where the rates are to finance the transaction. So as the -- obviously, as the centers come on board, as we consolidate some of the centers, as we get some of the buy-ups done, that's obviously going to drive incremental earnings. As a reminder, we just retired $1.1 billion of debt that will save us about $50 million a year of interest. So when you add up all those pieces, that's where we think the EPS accretion is going to come from.

Okay. And maybe just talk about your synergy target. What -- is that based on what you did with the first round of acquisitions? Or is it -- you learned some things from that first round? Do you think you can do even better with this round about these properties? How did you come up with that synergy number? And is it possible to talk about some of the big buckets that, that represents?

A.J., just real simply, I mean I think these are both revenue and cost synergies, but there's also an aspect of, as Brett described, the business development team being able to drive some growth in these centers. So it's a combination of those things. And yes, it's based on the experience. As we've indicated in our earnings calls, we're pleased with how the synergies have been delivered. Some of them have delivered above our expectations. So we've made some adjustments there. We still are in a period right now, where we've signed a definitive agreement, have some more information to learn about these centers before we close. So we'll have a chance to better refine this over the next 45 days before we even get possession of the assets.

Okay. Okay. I mean -- and I want to step back and ask some questions about the business, too, obviously, but this is a front burner thing, and it's a significant deal for you. The company is -- you're at 35% roughly of earnings coming from surgery centers today, as you said, if you complete the Conifer spinoff and what's in hand here, you'll be at roughly 46% from the surgery centers. Hopefully, people will start to give you some recognition in your valuation for that surgery center business, which we all know in the industry is considered probably the strongest surgery center portfolio out there. The market has been slow, I think, to give you that recognition. What's the company's appetite for trying to do things proactively to sort of force their hands in some ways?

Go ahead.

Well, A.J., we certainly believe that as the USPI business becomes a larger portion of the enterprise-wide earnings, we believe that more investors will start providing more value at a higher multiple as the business continues to grow. We -- in our opinion, we don't think we're getting the full credit that we should at this point. Reasonable people could debate that. Right now, based on our projections for 2021, USPI is about 37% of the business. And pro forma, we talked in our slides, we're going to be north of 40%. If you exclude Conifer, to your point, we're at 46%. And we're going to keep continuing to grow the business organically as well as additional either M&A or de novo development. The traditional M&A and de novo development that Brett and the team has been working on through the years as well as this new partnership agreement with SCD. So we're going to keep delivering the message that we think we should give more further credit for the fact that a larger portion of the business is coming from a great cash flow generating business, a capital-light business compared to the acute care business. And we just -- we got to keep performing and we got to keep messaging that you got to take into consideration the size of the ambulatory business and the economics associated with that. And we ultimately believe that will result in equity value creation.

Right. A.J., the thing I would add to that just is the foundation that's been laid in this organization around performance, accountability across all the business units that started 4 years ago that we're really carrying forward together at this point is a very important underlying foundation of Tenet Healthcare today. It's all the business segments, right? And then it's the commitment to growing the USPI segment as a growth business with a great cash flow profile. But at the same time, putting a lot of pressure on what it means to be 50% USPI by continuing to grow the hospital's earnings. And that's a very important part of what we are doing and have been doing. And so when you put the whole picture together, yes, we would agree with your sentiment. It's not just a sum of the parts issue, it's the foundation of what this organization has done over the last 4 years and is looking to continue over the next 4 or 5.

Right, right. You did -- in the Miami -- in the Florida transaction, as you've noted, you separated, you sold the hospitals, but you kept the surgery center business. So it's not like you're saying those are completely intertwined and have to be together, I guess, is -- will be one implication. That's one market. I mean I'm sure there's some synergies in some of the...

Absolutely right.

Yes. Anyway, I did have one e-mail question on this before I move on to a couple of others around the business as a whole. Someone had asked me, could you talk to us about how you get to the $200 million from the $130 million ex NCI EBITDA? Is that inclusive of the other 27 centers and what they're going to do? Or is it just from the buy-ups or -- and how do synergies factor into that, I guess? So trying to bridge that, the $130 million to the $205 million or so.

A.J., yes, it does include the ramp of the 27 centers. It does. It does not include the incremental earnings from the 50 or more centers that we plan on working with SCD to develop over the next 5 years. It does not include earnings from those 50 or more centers.

Right. Well, we've gotten pretty far into the presentation, and I hadn't asked you about COVID, so I now have to ask you about COVID, I guess. And it goes so pretty granular. The companies, and I think you guys from time to time have been giving updates. We sort of had this massive surge, which the company managed well through the third quarter. It seems like that has dropped off pretty precipitously. Have you seen the ability as that's dropped off? And I guess I should ask you just to confirm that your case count has continued to decline on COVID cases. Have you seen the ability to backfill with that with the non-COVID volumes, the procedures that perhaps were deferred earlier in the third quarter? Have you seen that start to come back? Any update you can provide us sort of sitting here mid-November?

Yes. In terms of -- A.J., in terms of the number of COVID inpatient cases at this point, so August was the peak with the Delta variant, came down in September. And then on our earnings call a few weeks ago, we mentioned that COVID cases at that time were in the 750 to 800 range. Right now, our cases have come down even further from there. They're roughly in the 650 to 700 range at this point. And listen, our hospital operators have just done a phenomenal job as well as the USPI team managing through the various peaks and valleys. And we have the ability to flex very quickly. And as COVID levels start to come down, volumes, the -- I'll call it the non-COVID volumes, have backfilled in many cases, the COVID cases have gone away. And our volume recovery and the progression and the improvement through the year, I think, speaks to that. And we feel good about where we're at currently as we think about moving into next year. Ultimately, volume levels will be dependent on where COVID levels are as we think about 2022.

Right, right. And I know this has been a point of debate among the different players in the industry, but a lot of the deferred procedures or the procedures that haven't come fully back tend to be the electives, maybe the orthopedic surgeries, et cetera. Is it your view that, that volume would still probably contribute more, given the payer mix associated with it than what you would see in the COVID despite the Medicare add-ons?

Yes, I think so. I mean it -- really, it's the mix and the acuity ultimately of those on a more sustainable basis that are meaningful. I mean, remember, the COVID case is maybe high acuity. They also come with a lot of additional costs, isolation rooms, PPE, a variety of other things. So I think that we're very committed to the high acuity, procedure-based, outstanding capabilities in intensive care, the type of work that we transfer in from outlying areas on a systematic basis in our markets. We think that's a sweet spot for us to continue to build our strategies by being -- providing a high-quality, high-service environment for those types of services, and we're going to continue down that path. You've heard us adding new trauma centers, adding new stroke centers, those are the types of things that we think will ultimately provide a sustainable path out of COVID.

Okay. Okay. I mean the other big topic of discussion, obviously, in the third quarter was around labor. I would ask you broadly just sort of recap. I mean we've had some companies say, my main pressure point was nurses out on quarantine in the midst of the surge. Others say, no, we've got nurses with burnout, nurses with a desire to take a break. How would you characterize what you're seeing in the labor situation? And how quickly that can moderate, at least back to something we were seeing late spring, early summer, if not all the way back to pre-pandemic levels?

Yes, A.J., I mean, I think, first of all, our clinical staff, all clinical staff, nurses included and maybe in particular, this has been a hard year for them, in particular. And we've put a lot of effort in our markets to working closely with our clinical staff to create a more sustainable environment, have the right incentives for them to want to work and supplement staff as needed, both local traveling and also through our own tenant resource agency. And look, despite all of that and having a very good platform upon which we manage our productivity and getting the appropriate resources to patients, there are shortages that are real market to market. And the difference has been that in the past, with COVID spikes, the shortages would come and go. The shortages as this COVID spike has waned, hasn't really alleviated as much as we've seen in prior COVID spike declines. So we're managing through it, and we're focused on that every single day in order to make the right choices. There are some cases where we've pulled back on services where we can't staff them safely because of a shortage. And we're thoughtful about that, too, because we don't want to create a situation where we don't have the appropriate staffing at the right time for those services. So I think this is going to be a month-to-month management issue until this labor market normalizes sometime in 2022.

Okay. Okay. When you think about 2022 and the outlook, what do you think are the biggest open questions as we sit here today for next year? I'm sure probably you'd say COVID to some degree, but hopefully, I would assume people are going to guide pretty conservatively around their assumptions for COVID. But what are the big swing factors in your mind as you think about next year?

Yes. I think, A.J., certainly, what we will see in terms of the intensity of COVID cases, we feel really good about managing through surges in COVID cases such as we've done twice this year, really, in January and February, and then in the August time frame, in particular. What could really move the needle, as I say, is if we got to the point where there was some form of shutdowns again. And we're not anticipating that. That would obviously have the most significant impact. And listen, our hospitals are performing incredibly well. We've talked about this over the past couple of weeks. They received, in our opinion, an A+ grade. They've just been doing a phenomenal job managing the ebbs and flows and the challenges associated with the pandemic. They're doing a great job managing cost despite some of these labor rate headwinds that Saum was just talking about. Our contract labor historically has been in, say, the 2% to 3% range. It's closer to mid-single digits now. But it would be probably a lot worse if it wasn't for the fact that Ron, Saum and the team, and Brad, even on the ambulatory side, have really dug into the contracts that we're entering into for this type of labor, making sure we have the right provisions in there, the ability to flex as the need moves up and down. So moving through that, I think -- so volumes obviously is a key variable next year. What we're seeing on labor, right? That's stating the obvious, depending if labor rates moderate more than maybe we're assuming or if they stay at the elevated levels, that will have an impact. We're assuming some moderation. But I think those are the obviously, the top 2 variables. And then, listen, our commercial mix has been quite strong, really over the past 1.5 years. And it's 2 things. Certainly, our focus on higher acuity, more complex cases and focusing on those type of services has been a key driver, we believe, of our commercial mix, which has been much more positive than the aggregate volume mix. Medicare cases have been recovering, but they're not at the same level of recovery as the commercial book of business. So the mix next year, we would expect that the commercial mix to probably still remain stronger than the overall mix for the company as a whole. So again, I think between volume, what we see ultimately in labor and the mix, you'll probably -- those will probably be 3 key variables in terms of where we would ultimately land next year. We talked a couple of weeks ago, 2 other items that -- Medicare sequestration in all likelihood, will resume at the beginning of next year. We talked about that, that's $80 million of revenue reductions next year. And then the fact that we sold our Miami hospitals, which had about $75 million of EBITDA this year. However, as we've said 3 weeks ago, we still expect to have some modest growth off of our 2021 base of $3.3 billion.

Right, right. Well, that's a good note to end on. I appreciate you guys running through everything, including the transaction from last night in more detail. I think that's helpful for people. And again, I really appreciate Tenet participating once again in the conference this year. Hopefully, next year, we'll be doing it in person. But thanks, everyone, and we will speak to you soon.

Take care, A.J. Thank you.

Thanks, A.J., as always.

Thanks, A.J.