HealthSouth eyes unloading units to cut debt, believes holders will go along with idea

By Paul Deckelman

New York, Aug. 14 - HealthSouth Corp. - which among other things, runs a network of surgery centers - is thinking about going under the knife itself, considering the sale or spin off of those centers, plus its outpatient rehabilitation and diagnostic services businesses. Most of the proceeds from such a divestment, should it occur, would go toward de-leveraging the company's balance sheet.

The slimmed-down HealthSouth that would remain after such a radical corporate liposuction would be what company president and chief executive officer Jay Grinney called "a pure-play post-acute provider," only about half its current size - but it would be focused on the most lucrative portion of its business, providing inpatient rehabilitation services for people trying to come back from serious medical conditions like strokes and brain or spinal-cord injuries. That business currently accounts for fully 57.9% of HealthSouth's consolidated net revenues - and a whopping 86% of its operating earnings.

Grinney, company chief financial officer John L. Workman, and other HealthSouth executives outlined the Birmingham, Ala.-based healthcare services provider's ambitious "strategic repositioning" plan on a conference call with analysts Monday following the company's announcement of its second-quarter financial results.

Grinney at that time also announced plans to seek stockholder approval for a 1-to-5 reverse stock split, which would lower the number of outstanding shares to 80 million from about 400 million presently, and to seek re-listing on the New York Stock Exchange.

He also said that the company - which is trying to move past its accounting scandals and other problems of the last few years - would retain the HealthSouth name, which he said "is synonymous with high quality rehabilitative care," according to market research, and is "valuable brand equity . . .part of our heritage that we're holding onto."

Loss of $51.7 million

In the second quarter ended June 30, HealthSouth posted a net loss of $51.68 million (13 cents per share), down from its year-earlier deficit of $62.41 million (16 cents per share). It cut its pre-tax loss from continuing operations to $28.9 million from $45.9 million a year earlier. Revenues for the quarter were $787.5 million, a 3.8% decline from the same quarter a year ago.

HealthSouth has hired Goldman Sachs & Co. to explore various strategic alternatives for its surgery centers and outpatient rehabilitation services divisions, possibly including their sale or spin off - with Deutsche Bank having previously been retained to shop its diagnostic centers business around.

Lacking 'comprehensive theme'

Grinney said that right now HealthSouth "doesn't have a comprehensive theme or strategy - [it's] four very different businesses that happen to be under one umbrella."

He said HealthSouth - which as of the end of last year operated 93 inpatient rehabilitation facilities and 10 long-term acute care hospitals - wants to concentrate its focus on the post-acute impatient rehabilitation services business, a $125 billion annual market that is highly fragmented and ripe for consolidation, with the top five industry players combined accounting for less than 20% of total revenues. While HealthSouth wants to take advantage of such industry conditions, he said, "we can't afford these growth opportunities with our [current] debt."

As of June 30, HealthSouth carried $3.334 billion of total debt on its balance sheet, including $1 billion of bonds which the company sold in June - $625 million of 10¾% senior notes due 2016 and $375 million of floating-rate notes due 2014. The capital structure also includes $400 million of 6½% convertible perpetual preferred stock, sold in March.

In February, the company announced the recapitalization of its then-outstanding debt, entering into $2.55 billion of new senior secured credit facilities and a $1.3 billion senior unsecured interim loan. The re-capitalization proceeds were used to pay off virtually all of its then-outstanding $2.349 billion of bonds and its bank debt, which then consisted of a $200 million senior unsecured term loan and $355 million senior subordinated term loan. Proceeds from the March convertible preferred sale and the June junk bond sale were, in turn, used to repay the $1.3 billion interim loan.

Pays down $25 million of debt

At the end of June, the company had $50 million of outstanding borrowings under the revolving credit agreement portion of its credit facilities, the same amount that was due at the time of the refinancing. Since the end of the second quarter, Workman said, it has paid down $25 million of the revolver borrowings.

The company's earnings announcement also noted that it had $78.657 million of net interest expenses for the just-past quarter - down from $80.9 million a year earlier, the CFO said, with a reduction in debt due to the issuance of the preferred stock issued as part of the refinancing. Cash and cash equivalents at the quarter's-end were $53.9 million.

Workman also said that the latest results reflected a mark-to-market favorable adjustment of $18.6 million as a result of the company's interest-rate swap on $2 billion of its term loan, which locks in the rate used to set its variable interest rates at 5.22% for that portion of the debt, "so we would expect that to be a favorable position to be in."

The refinancing, he declared "was done to eliminate the uncertainties of future financings, to provide relief on many out-of-market covenants that existed with the company's old debt structure, and to give the company more operating flexibility as well as limit the amount of near-term maturities the company was going to be facing in the new financing structure."

He went on to say that while the refinancing was "not done in anticipation" of the strategic repositioning effort announced Monday, "we do believe it allows us to effectively de-leverage the company with any proceeds, including amounts that are already expected from a tax refund and potential derivative proceeds."

He said that now the company has pre-payable debt in its capital structure while before it did not - when it refinanced, it had to first get lender approval to pre-pay the term loan agreements - "so we do believe we are in a good position with our capital structure."

'Substantial' part of proceeds to repay debt

Grinney and Workman did not hazard a guess as to how much the company might get by selling or spinning off the three divisions, with the CEO saying only that "a substantial portion" of the expected proceeds would be used to de-leverage the company, "creating a balance sheet that will allow us to capitalize on growth opportunities in the post-acute segment."

As of the end of last year, HealthSouth's surgery division, which will be shopped around by Goldman Sachs, had 158 ambulatory surgery centers and 3 surgical hospitals, providing facilities and medical support staff necessary for physicians to perform non-emergency surgical procedures in various specialties, such as orthopedic, GI, ophthalmology, plastic, and general surgery. It accounted for 24.5% of the company's revenues and 18.1% of operating earnings.

The company's outpatient segment, also being marketed by Goldman, operates 620 outpatient rehabilitation facilities, either HealthSouth-owned or owned by other health care providers, offering a range of rehabilitative health care services, including physical therapy and occupational therapy, with a focus on orthopedic, sports-related, work-related, hand and spine injuries, and various neurological/neuromuscular conditions. In the most recent quarter, this division accounted for 11% of revenues and 6.8% of operating earnings.

The diagnostic division that Deutsche Bank is assessing strategic alternatives for consists of 85 imaging centers offering MRI, CT scan, X-ray, ultrasound, mammography and nuclear medicine services, and fluoroscopy. It accounted for 6.6% of revenues and 10.9% of operating earnings in the second quarter.

One-year timetable

"Clearly, we want to move this process along as fast as we possibly can," Grinney said, estimating that the process of soliciting offers for the three divisions, weighing them and structuring deals, should that occur, would likely take about a year to complete. He said that the company has already received several expressions of interest for the surgery centers.

Grinney said HealthSouth "would have to obtain consents" from its bond holders and its other debtholders on any possible sale or spin-off of any, some or all of the three divisions being shopped around. However, the CEO added that "since we did the refinancing, and we have so much of our debt that is pre-payable, I think our lenders will be very positive."

Workman said that a spin-off of one or more of the units "would require more permission. A sale would require less permission - that's going to the bank group as to use of proceeds, basically, and since we've disclosed that we would use most [of any proceeds] for de-leveraging, we don't think that will be a big issue."

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