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
 HCA’s performance and business strategies.
 Impact of the proposed change to prospective
reimbursement by Medicare/Medicaid.
 Should it go for growth or profitability.
 HCA’s concern of losing it’s A bond rating.
 HCA’s 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 nation’s 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 it’s
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.
HCA’s Performance
 HCA’s 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.

 HCA’s 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.

 HCA’s bond rating is expected to drop from A- in 1980 to BB

in 1981.

 HCA had 32.2% annual revenue growth.

 HCA’s main financial goal is to maintain return of equity of

17%.It has been increasing throughout the Beginning.

• Company’s 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.

 The hospital industry grew a lot during this period due

to programs like medicare and mediciad.

 From 1978 to 1981, HCA was having high market

growth rate as it continued to acquire other
proprietary hospital management companies and non-
profit 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 hospital’s 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.

 A less aggressive financial strategy than previous years

should be adopted since there is a lack of growth
opportunities by acquiring hospitals and constructing
new units.

 However, the financial strategy must be more

aggressive than that of its competitors in order to
maintain the firm’s market share in the industry as
well as to take advantage of opportunities to grow
through natural expansion.
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

 This is because its major competitors’ credit ratings range

from BB+ to B+.

 Those with lower bond ratings than HCA are still able to
achieve higher returns on equity despite the lower bond
rating.

 The firm needs to ensure its ability to access the debt

markets at the chosen debt ratio.
 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.
HCA’S RATING COMPARED TO ITS
COMPETITOR’S BOND RATING.
The Major Player’s…

Year HCA Human American National Lifemar

a Inc. Medical Medical k
International Enterprises
, Inc. , Inc.

1980 A NR Ba Ba Ba

1981 A B+ NR BB+ BB+

HCA v/s Humana…
SELECTED MEASURES OF PERFORMANCE FOR HCA AND
HUMANA
HCA HUMANA

1981 ROE 23.7% 43.1%

1981 ratio of market to book 2.8 4.8

value
Growth in hospitals, 1976- 30.1% 6.8%
1981
Growth in net income, 1976- 32.4% 54.6%
1981
1981 revenues per bed $48,300 $103,700

1981 net income per bed $2,200 $5,700

Conclusion…
 HCA indicates low credit risk as compared to other
Hospital chains.
 HCA’s 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- borrower’s 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

 The firm will choose a debt ratio that will result in a low
WACC and appropriate credit rating.

 If the retained earnings exceed capital expenditure, the

firm won’t need to borrow as much money

 Lesser the rating ,higher the risk

FUTURE STRATEGY
 Future Financial Strategy
 HCA’s 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.
 Funding Strategy
 The company’s initial objective is to incur capital expenditure of $575
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 firm’s

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 firm’s ability on raising
funds:

 A firm’s credit rating which is affected by a firm’s

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 firm’s 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…