WTAE-TV, Pittsburgh -- 1/14/03

Tenet's Prognosis: Lots of Complications

Tenet Healthcare, the nation's No. 2 hospital operator, is facing a conundrum. CEO Jeffrey Barbakow has admitted that Tenet (THC) earned 20% of its profit growth last year by employing a Medicare billing loophole that will soon be closed. Without that strategy, Tenet could get saddled with more of the financial liability for taking care of the sickest patients. Yet it continues to pursue an aggressive growth plan of targeting aging baby boomers who demand the best in cardiac care, orthopedic surgery, and other risky procedures.

Some who follow Tenet worry that it may get blindsided. During an analysts meeting in December, Sheryl Skolnick of Fulcrum Global Partners asked Barbakow and his management team how Tenet could maintain its profitability while being paid less to take on more risk. "They had these looks on their faces like they were deer caught in the headlights," Skolnick recalls. "Clearly, they haven't really thought this through."

Some quick thinking is in order. On Jan. 1, the Santa Barbara (Calif.) outfit stopped its much-criticized billing practices for Medicare "outliers," or patients who undergo exceptionally risky and expensive procedures. The Centers for Medicare&Medicaid Services launched an investigation into Tenet's outlier strategy last fall, after an analyst revealed that these payments were 17% of Tenet's total Medicare payments, far greater than the national average of about 5%.

PROFIT PRESSURES. Revenues from outliers are expected to plummet from $65 million a month to $8 million, leading Tenet to lower earnings estimates for the year ending May 31, 2003, from $1.4 billion to less than $1.3 billion. For fiscal 2004, Tenet expects earnings to drop even further, to $950 million. Investors have pushed Tenet's stock down nearly 50% -- to around $16.80 on Jan. 10 -- since October, when the billing irregularities first came to light.

Tenet's profits are under pressure for other reasons, too. It plans to change the way it bills private insurers, making it less reliant on stop-loss payments, which provide a hospital's financial safety net when a patient's treatment costs exceed expectations, and more on fixed prices that it negotiates with insurers.

Barbakow believes Tenet will be able to raise prices enough to cover the most costly patients. But analysts say that's far from a sure bet. "They could enter into a contract and then find that cost expectations were not correct," says Clifford Hewitt, an analyst for Legg Mason Wood Walker. Tenet might then end up swallowing more of the loss for expensive patients than it has in the past.

SYSTEM CHECKUP. On top of that, Tenet now faces relentless legal challenges. On Dec. 19, officials from the U.S. Attorney's Office raided Tenet's Alvarado Hospital Medical Center in San Diego, carting away 24 boxes of records related to Alvarado's physician-recruitment practices. On Jan. 2, the Justice Dept. subpoenaed Medicare billing records from 19 Tenet hospitals. And on Jan. 9, Justice filed suit on a separate issue involving Tenet's Medicare billing practices from 1992 to 1998. In addition, the company is facing an informal Securities&Exchange Commission investigation.

An already shell-shocked Wall Street barely flinched when Tenet announced the most recent inquiries. But some outsiders fear matters may be worse than they look -- especially the situation brewing in San Diego. Health-law experts say the Alvarado search warrant clearly shows that authorities are looking for potential violations of the federal antikickback and Stark laws, which prohibit financial rewards to doctors who refer patients to the hospitals at which they practice.

Plus, the investigation could spread beyond Alvarado. Among the documents requested in the warrants are "records discussing strategies and/or plans for increasing patient admissions" at any Tenet facility. The officials also demanded Tenet bank records and tax returns for the last six years. "The government doesn't care about violations at just one hospital," says Michael Nolan, a health-care lawyer and partner with Lowenstein Sandler in Roseland, N.J. "They're looking across the board at the whole Tenet system."

NO SO GREAT.Tenet spokesman Harry Anderson says no documents were requested from Tenet's corporate headquarters and that the investigation so far has not extended beyond Alvarado. Says Anderson: "If they're looking deeper, we have not been informed or asked to supply any other information."

Still, the Alvarado mess can only add to Tenet's legal bills, and it may further crimp profit margins. Legg Mason's Hewitt expects operating margins to drop from 20% in 2002 to 15% in 2004. "You take away those outliers, and the margins aren't so great," Hewitt says. Determining how Tenet can improve its cost efficiency and get margins back on track, he adds, "will be a several-year process."

Barbakow admits Tenet will have to cut costs. That infuriates many employees, who say Tenet is already too tight-fisted. For example, to save money, it has been slashing hospital cleaning staffs and outsourcing much of the janitorial work. Cleanliness has declined as a result, critics say. "Our operating rooms weren't scrubbed down or sanitized often enough," says one former Tenet administrator, who asked not to be named. Responds Tenet's Anderson: "We flatly and vehemently deny it. We meet all the federal and state guidelines for cleanliness and infection control."

"INTENSE REVIEW." Analysts say Tenet will need to look at the corporate level, rather than the hospital level, for places to trim the fat. That may mean delaying new-technology purchases and other corporate initiatives. Tenet's Anderson says he doesn't know when investors can expect a plan to get profits back on track. "For the past two months we've been focused on the outlier situation," he says. "Now, we're turning our attention to an intense review of operations."

With the government and investors breathing down Tenet's neck, Barbakow will have to work fast -- or Tenet's prognosis may continue to decline