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Case study on Hospital Corporation Of America

Siddesh Trivedi 171 Shivendra Singh 172 Navjyot Singhvi 173 Radha Thakore 214 Ankit Shah 317 Dishank Shah 318 Fenil Shah 319

Agenda
HCAs performance and business strategies.

Impact of the proposed change to prospective

reimbursement by Medicare/Medicaid. Should it go for growth or profitability. HCAs concern of losing its A bond rating. HCAs bond rating comparison with its competitors. Importance of credit rating while establishing a target debt ratio. Future financing strategies. Recommendations.

Introduction
Hospital

Corporation of America(HCA) is proprietary hospital management Company .

Beginning with only 150 bed hospital in 1968,HCA grew

to become the nations largest hospital management company.


Revenue of $2.1 Billion in 1981. HCA had 32.2% annual revenue growth and 32.6%

annual earnings growth.

Cont
The company has been following an acquisitive strategy by

taking over hospital companies and not-for-profit hospitals.

Firm is also considering expanding into new health service

areas like home health care and outpatient surgery.

Ability to sell equity and other financial securities. Revolving Bank Credits, industrial revenue bonds, long

term mortgage loans funded completed hospitals and acquisitions.

In 1981 HCA added $891 million of debt to its

balance sheet.
Sudden increase in level of debt made HCA the

highest leveraged company in the US with a single A Bond rating.


60% target ratio of debt to total capital was one of

the explicity stated goal of the HCA

Financial leverage has increased substantially over

the past two years due to HCA borrowing for its acquisition funding needs.
It was only focusing on increase in market share

and not on increasing the profit.

HCAs Performance
HCAs net profit margin has declined in stark

contrast with that of its competitors.


HCA has focused on an acquisitory strategy

especially by taking over not-for-profit hospitals.


HCAs asset turnover has declined. HCA has

acquired several old, out-dated assets which have not been able to generate revenue efficiently.

Cont..
The interest coverage ratio has declined from 3.73 in 1980 to

2.40 in 1981.
HCAs bond rating is expected to drop from A- in 1980 to BB

in 1981.
HCA had 32.2% annual revenue growth. HCAs main financial goal is to maintain return of equity of

17%.It has been increasing throughout the Beginning.


Companys objective is to incur capital expenditure of $575

million per year.

In the early 1970s, HCA was having low relative

market share as compared to high market growth rate. It acquired a substantial number of existing hospitals and constructed several new hospital units.
to programs like medicare and mediciad.

The hospital industry grew a lot during this period due

From 1978 to 1981, HCA was having high market

growth rate as it continued to acquire other proprietary hospital management companies and nonprofit hospitals.

IMPACT OF PROSPECTIVE REIMBURMENT SYSTEMS BY MEDICARE/MEDICAID

PREVIOUS CONDITIONS
Cost-based

Included only depreciation and interest.

Excluded costs of research, losses on bad debts, and

expenses for charitable cases.

Impacts
Provides hospitals with stable revenue streams that were largely

insulated from economic cycles, inflation, and other economy

wide-risks.
Hospitals tended to compete with one another on the basis of

quality and breadth of services, reputation of medical staffs, and


advertising, rather than on the basis of low prices.

Prospective Reimbursement Systems


Hospitals would be paid on the basis of prospectively set rates

rather than actually realized costs.


If a hospital provided services at a cost lower than the

established rates, it earned a profit; if not, it realized a loss.


A system is designed in which capital costs would be

prospectively set along with the other costs of providing services.

Impact of the system


Allowable interest expenses would continue to be paid retrospectively. ROE provisions would be dropped altogether. This outcome would place even greater pressure on the private-patient

side of a hospitals business to provide an adequate return on capital.


Due to this, It seemed probable that the virtual elimination of losses

and subsidization of capital costs provided by the cost-based

reimbursement system would be reduced.


This would instill greater volatility in hospital revenues and earnings.

SHOULD HCA PUSH FOR MAXIMUM GROWTH OR SLOW DOWN AND FOCUS ON INCREASING PROFITABILITY?

HCA would like to see the annual growth rate in

the 25-30% range, although they have also set a minimum of 13%.
This would signal aggressive action in the

company and with this growth rate HCA would experience a dramatic increase in leverage.

Vice President Bill Mc Innes believes that in order

for HCA to compete with other management companies in the industry they must continue acquisitions.
An increasing growth rate does appeal to the

investors.
But it is not necessary to take on this kind of risk

when uncertainties lie in the future

More importantly, there is evidence that increasing

growth does not necessarily make you more profitable.


Humana's growth in hospitals over the past 5 years is

6.80%, that's almost a quarter of HCA's at 30.1%, yet they realized a growth in net income of 54.60%.
HCA on the other hand only realized a growth in net

income of 32.40% IN 1980-81 (Exhibit 1).


Hence the growth rate is not a sole determinate of

future performance. In addition, a company certainly wants to allow room for future growth.

Recommendations
HCA should adopt a financial strategy that is less

aggressive than previous years but more aggressive than that of its competitors. should be adopted since there is a lack of growth opportunities by acquiring hospitals and constructing new units.
aggressive than that of its competitors in order to maintain the firms market share in the industry as well as to take advantage of opportunities to grow through natural expansion.

A less aggressive financial strategy than previous years

However, the financial strategy must be more

SHOULD HCA BE CONCERNED ABOUT THE POSSIBLITY OF LOSING ITS SINGLE A BOND RATING?

HCA should not be concerned about the possiblity of

loosing their single A bond rating


from BB+ to B+.

This is because its major competitors credit ratings range

Those with lower bond ratings than HCA are still able to

achieve higher returns on equity despite the lower bond rating. markets at the chosen debt ratio.

The firm needs to ensure its ability to access the debt

If HCA decreases their debt ratio to 60%, they will

retain their A bond rating in exchange for: a decline in their ROE (below target) growth rate.

The expectation that the firm will only have high

growth in the next 5 years after which the firm will mature indicates that the firm should pursue aggressive financial strategy even at the cost of losing its single-A bond rating.
The firm will be able to regain its single-A bond rating

when:-it matures since excess cash generated as a cash cow can be used to repay debt and reduce its debt-to-capital ratio.

HCAS RATING COMPARED TO ITS COMPETITORS BOND RATING.

The Major Players


Year HCA Human a Inc. American National Lifemar Medical Medical k International Enterprises , Inc. , Inc.

1980
1981

A
A

NR
B+

Ba
NR

Ba
BB+

Ba
BB+

HCA v/s Humana


SELECTED MEASURES OF PERFORMANCE FOR HCA AND HUMANA
HCA HUMANA

1981 ROE 1981 ratio of market to book value Growth in hospitals, 19761981 Growth in net income, 19761981 1981 revenues per bed 1981 net income per bed

23.7% 2.8 30.1% 32.4% $48,300 $2,200

43.1% 4.8 6.8% 54.6% $103,700 $5,700

Conclusion
HCA indicates low credit risk as compared to other

Hospital chains. HCAs cost of borrowings is less as compared to its other Hospital chains. HCA has strong capacity to meet its financial commitments as compared to others.

IMPORTANCE OF CREDIT RATINGS WHEN ESTABLISHING A TARGET DEBT RATIO.

Debt-To-Capital Ratio
A measurement of a company's financial leverage

Debt includes all short-term and long-term

obligations. Total capital includes the company's debt and shareholders' equity,

The higher the debt-to-capital ratio, the more debt the

company has compared to its equity.


weak financial strength because the cost of these

debts may weigh on the company and increase its default risk

Components of credit analysis


Character-managements integrity and its

commitment to repay the loan. Covenants-terms and conditions the borrowers and lenders have agreed upon Collateral- includes assets offered as a security for the debt Capacity to pay- borrowers ability to generate cash flow to repay its debt obligations

Importance of credit ratings


Amount of debt that is required by the firm in the future. If the retained earnings of the company is less than the

capital expenditure, the firm then needs to borrow more money WACC and appropriate credit rating.

The firm will choose a debt ratio that will result in a low

If the retained earnings exceed capital expenditure, the

firm wont need to borrow as much money

Lesser the rating ,higher the risk

FUTURE STRATEGY

Future Financial Strategy


HCAs main financial goal is to maintain return of equity of 17%. The return of equity in the last 2 years has been in the range of

18-19% shareholders will continue to invest can be achieved changing the debt ratio of the company. This will also help increase retained earnings and then help reduce large amounts of debt and interest expense in the coming year Maintaining a dividend growth rate of 15% is another financial goal to consider as it is important to keep paying dividends at a steady level as it sends out a positive signal to investors that the firms earnings are steady . stock price performance will improve in the long run.

The companys initial objective is to incur capital expenditure of $575

Funding Strategy
million per year

firm should consider maintaining $575 million capital expenditure for

the next 5 years instead of capital expenditure ballooning because it will be difficult for revenue growth to keep up with this expenditure growth in the long run.
Capital expenditure is deferrable first and foremost because paying off

our debt in the next 5 years is obligatory


This does not mean that capital expenditure cannot be incurred.
Expected to decrease in the long run since the acquisition market is

shrinking and the quality of non- profit hospital assets is expected to improve in the future

Next few years, future debt is going to be due for

repayment.
In the long-run, it will impact on the firms

dividend payment when the repayments are made.


HCA could possibly change their source of

financing to floating rate debt which has relatively lower interest rates as of now and is unlikely to rise as high a rate as that for commercial paper.

The effect of debt policy firms ability on raising funds:


A firms credit rating which is affected by a firms

chosen debt policy is one of the factors that affect how much the firm can borrow.
If HCA has a bad credit rating, it would be difficult for

HCA to access debt markets and this limits the number of profitable investments that HCA can undertake.
HCA needs to choose a debt policy that will ensure

that the firm is able to access debt markets since HCA still needs debt to fund its capital expenditure.

Recommended financial strategy, target bond rating and target debt ratio.
The recommended target debt ratio for HCA is from 55% to

60%
company currently does not exceed its target debt ratio of

68.8% as indicated by the company.


The debt-to-capital ratio of 68.8% is inappropriate

The firm should increase its debt level to fund its

increasing capital expenditure but must ensure that it does not exceed its 60% debt ratio policy.

The recommended target bond rating for HCA is from A to BBB.

Even though the table in indicates a target bond rating between BBB to B+.

HCA is a market leader in the industry with a proven track

record and a good reputation .

Market expectations of improved future profitability suggests

that the firms actual credit rating should be around A to BBB.

The target rating of A to BBB is appropriate as it allows the firm

to access the debt market.

The firm will still be able to access the debt market if the bond

rating is within this range.

THANK YOU