Fitch Downgrades Team Health IDR to 'CCC'

Fitch Ratings has downgraded its Long-Term Issuer Default Rating (IDR) on Team Health Holdings, Inc. (TMH) to 'CCC' from 'CCC+' and removed the Positive Rating Outlook assigned prior to TMH reporting results for the first nine months of 2022, in which Fitch-calculated EBITDA declined y/y by nearly 30%.

Fitch previously assumed stabilizing fundamentals and expected progress in de-risking the capital structure, with a focus on refinancing the company's non-extended term loan due February 2024 and senior unsecured notes due February 2025. However, pressure from secular- and pandemic-driven challenges to volume, pricing and operating margins has since increased, driving down EBITDA, albeit with FCF still positive but now constrained by significant balance sheet exposure to rising interest rates.

With Fitch-calculated leverage now exceeding 8.0x through the senior secured debt and 10.0x overall, Fitch sees access to the debt capital markets to refinance significant near-term maturities as increasingly limited. This is the key driver of Fitch's rating action, as Fitch sees $1.2 billion of term loans due February 2024 materially elevating near-term risk of a distressed debt exchange or principal payment default.

Key Rating Drivers

Leading Position in Increasingly Challenged Subsector: TMH is one of a handful of large national providers in the fragmented outsourced healthcare staffing market, with leading scale enhancing its capabilities in contracting with hospital systems and commercial health insurers. That said, with revenues sourced primarily from contracted physician services and emergency department (ED) staffing comprising the majority thereof, Fitch expects top line growth prospects to be constrained by secular pressure on ED care pricing and volumes (especially lower-acuity visits).

Sources of secular volume pressure include both larger, better-capitalized health insurers and the expanding universe of capitated value-based care providers focusing on reducing ED use (with increasingly prevalent high-deductible plans constraining demand) and increasing competition from alternative settings including urgent care clinics, evidencing the subsector's weak barriers to entry. Volumes will also face pressure from Medicaid eligibility redeterminations permitted following the COVID-19 Public Health Emergency, which is now expected to be extended until at least mid-April 2023.

On the pricing front, ED care reimbursement faces a 10% cut in 2023 on Medicare cases comprising about 1/4 of revenue absent uncertain legislative intervention. Fitch also expects commercial rates to remain pressured by the evolving implementation of the No Surprises Act (NSA), with health insurers allegedly engineering low median in-network payment rates for ED care to depress NSA-arbitrated out-of-network payment determinations.

Pandemic-Driven Volatility Further Pressuring Margins: The ebb and flow of the COVID-19 pandemic has been disrupting operations, with depressed ED patient visits (and elective volumes generally) driving inefficiencies in clinical labor expense (comprises >80% of TMH costs), given the need to maintain hospital staffing readiness. The cost of staffing the ED to handle volatile volumes that have increasingly disappointed in recent quarters, and the inefficiency of ED physicians handling sub-license tasks amid constrained nursing labor availability, have created negative operating leverage and pressured EBITDA margins. Fitch sees limited opportunity for TMH to improve margins in the near-term, which in turn has negative implications for its ability to materially reduce leverage from unsustainably-elevated levels.

Elevated Leverage and Near-Term Maturities Pose Increasing Default Risk: Fitch sees heightened near-term risk of a distressed debt exchange or principal payment default with leverage now exceeding 8.0x through the senior secured loans and 10.0x overall, as this is likely to limit TMH's access to capital markets to refinance its near-term maturities. Key among these are the $300 million L+300 Revolver due November 2023 (undrawn with $288mm available as of September 30), the $1.2 billion L+275 Term Loan B due February 2024 and $714 million of 6.375% senior unsecured notes due February 2025.

Even if lenders are inclined to be supportive, a refinancing and/or extension of these near-term debt maturities may be further complicated by the maturity of its $1.4 billion S+525 Term Loan B due March 2027 springing to November 2024 absent an earlier transaction reducing all outstanding TMH senior unsecured notes to $250 million or less, thus likely requiring the holistic but more challenging approach of refinancing most or all of its balance sheet amid notably adverse capital markets conditions.

Liquidity Supports Ordinary-Course Operations; FCF Positive but Limited: While liquidity as of Sept. 30, 2022 included $384 million of cash and an undrawn $300 million revolver (available at least through its November 2023 maturity) is more than adequate to fund ordinary-course operations, it is insufficient to address the full quantum of near-term maturities absent access to the debt capital markets. While the modest capex needs of the business facilitate positive FCF, Fitch expects margin pressure to constrain FCF to modestly positive levels in the near term, reflecting an ascending cash interest burden with at least 3/4 of its debt exposed to rising interest rates.

Fitch also expects working capital could be a further constraint, with DSO in A/R potentially increasing from the bottom of its historical range of 65-70, cash deposits increasing to support an anticipated ramp-up in payor litigation claims, and accrued liabilities declining after paying out about $60 million in 4Q22 to settle certain legacy divestiture liabilities and physician compensation litigation (notably follows about $50 million paid in 2021 to settle federal False Claims Act litigation, with considerable litigation still pending, including a large payor claiming over $100 million in upcoding). That said, Fitch notes that TMH recently prevailed in litigation asserting that UnitedHealth (UNH) underpaid for certain pre-2020 anesthesia claims in Florida (netting it $11 million plus costs and interest), and has several other cases pending entailing what TMH believes are similar facts.

Other Challenges Remain: Margins and FCF remain under pressure from the evolving implementation of the NSA and an ongoing dispute with UNH, but Fitch does not expect material further downside on this front. TMH is out-of-network with UNH after the latter unilaterally cut reimbursement rates and the parties commenced litigation. As Fitch does not assume this dispute will be resolved in the near term, Fitch's projections for TMH do not reflect any potential future improvement in payor mix or litigation outflows or inflows. As TMH has steadfastly and publicly stated that it does not engage in balance billing, Fitch does not expect any material related pressure on collections.

Derivation Summary

The 'CCC' Long-Term IDR on TMH reflects secular and pandemic-driven headwinds to ED care volume and pricing, which have compressed operating margins and increased leverage to levels that Fitch believes are unsustainable. The company's credit profile benefits from good depth and competitive scale relative to peers Mednax (not rated) and Envision Healthcare (not rated) in physician staffing service lines including emergency medicine and anesthesia. With TMH owned by affiliates of Blackstone after a 2017 LBO (and peer Envision acquired by KKR in a 2018 LBO), private equity ownership has influenced the credit profile, generally entailing higher leverage and more aggressive financial policy.

While the company's credit profile has also benefitted historically from low capex needs facilitating more consistent and stable FCF generation than health care providers generally, Fitch anticipates only modest positive FCF beyond 2022 due to recent compression in operating margins and the company's significant balance sheet exposure (at least 75%) to rising interest rates.

Moreover, the positive FCF that TMH has generated historically has largely funded expansion as opposed to reducing leverage by paying down debt. Fitch's ratings further reflect its view that high leverage, now exceeding 8.0x through its senior secured debt and 10.0x overall, is likely to limit TMH's access to capital markets to refinance near-term debt maturities, elevating near-term risk of either a distressed debt exchange or principal payment default.

The 'B-'/'RR2' ratings for TMH's senior secured debt, including its revolver and term loans, are notched above the 'CCC' Long-Term IDR to reflect Fitch's expectation of a 71%-90% recovery under a bankruptcy scenario. The 'CC'/'RR6' rating on TMH's senior unsecured notes is notched below the 'CCC' Long-Term IDR to reflect Fitch's expectation of a 0%-10% recovery under a bankruptcy scenario, which solely includes an assumed 1% concession payment from senior secured creditors.

Fitch estimates an enterprise value (EV) on a going concern basis of $2.4 billion for TMH after deducting 10% for administrative claims, which is based on assumed post-reorganization EBITDA of $374 million and a 7.0x multiple. This post-reorganization EBITDA estimate is $40 million (12%) above Fitch's 2022 EBITDA forecast of $334 million, as Fitch expects at least a portion of certain volume and pricing pressures driven by the COVID-19 pandemic and the company's ongoing payor dispute with UNH is likely to subside within the time horizon in which an exit from a restructuring process is likely to occur.

The primary drivers of the post-reorganization EBITDA estimate are the negative implications of commercial payor contract disputes and the assumed persistence of constrained profitability. To date, Fitch does not believe that the COVID-19 pandemic has altered the longer-term valuation prospects for the healthcare services industry and Fitch's post-reorganization EBITDA and multiple assumptions for TMH are unchanged from the last ratings review.

The 7.0x multiple used for TMH reflects a stressed multiple versus the multiple of approximately 11.0x that Blackstone paid for TMH in 2017. Fitch also notes that KKR paid about 10.0x EBITDA for staffing industry peer Envision Healthcare. This 7.0x multiple is also closely aligned with historical observations of healthcare industry bankruptcy emergence multiples. In a recent study, Fitch determined that the historical median exit multiple for healthcare and pharmaceutical industry bankruptcies was about 6.3x.

Fitch's recovery analysis also assumes the company's $300 million revolver is fully drawn and includes this amount within an estimated $2.95 billion of senior secured claims, which further includes Fitch's estimate of certain to-be-accrued PIK interest that would otherwise be due in February 2024.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Revenue growth in the low-single digits through 2025, surpassing pre-pandemic revenue in 2023;

EBITDA margins sustained in the 7%-8% range over the forecast period;

Acquisitions totaling $25 million annually and no shareholder distributions;

CapEx of $35 million-$40 million annually and annual FCF of nearly $100 million in 2022, contracting to about $25 million thereafter;

Leverage sustained above 8.0x over the forecast period; and

No allocation of FCF towards voluntary debt repayment.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Extension of maturity or refinancing of its $300 million L+300 revolving credit facility due November 2023 or obtaining a comparable alternate source of liquidity;

Refinancing of its $1.2 billion L+275 Term Loan B due February 2024 and its $0.7 billion of 6.375% senior unsecured notes due February 2025, provided such refinancing would not comprise a distressed debt exchange as defined by Fitch;

Significant improvement in operating margins, reduction in leverage and improvement in capital markets conditions supporting a refinancing of near-term debt maturities.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Announcement of transactions comprising a distressed debt exchange as defined by Fitch;

Failure to extend the maturity of or refinance its $300 million L+300 revolving credit facility before maturity in November 2023 or obtain a comparable alternate source of liquidity;

Failure to refinance its $1.2 billion L+275 Term Loan B due February 2024 or its $0.7 billion of 6.375% senior unsecured notes due February 2025;

Failure to pay interest and debt principal when due.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Sources of Liquidity: As of September 30, 2022, sources of liquidity include $384 million of unrestricted cash and an undrawn revolver of $288 million (net of $12 million outstanding letters of credit), the latter of which will be accessible only through its November 2023 maturity absent a further extension or refinancing. While the modest capex needs of the business support positive FCF generation, Fitch expects margin pressure to constrain FCF to modestly positive levels over the rating horizon, particularly with about 3/4 of its debt exposed to rising interest rates.

Issuer Profile

Team Health Holdings, Inc. (TMH) is a U.S.-based national healthcare outsourcing company that supports more than 2,600 civilian and military hospitals, clinics, and physician groups in 48 states by providing staffing, administrative and consulting services. TMH is a large player in the physician staffing market based on revenue, patient visits, and number of clients, focusing on ED care (comprising the majority of its revenue), anesthesiology and inpatient services. TMH has been privately owned by affiliates of Blackstone since its February 2017 LBO.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

TMH has an ESG Relevance Score of '4' for Exposure to Social Impacts due to societal and regulatory pressures to contain growth in healthcare spending in the U.S. This dynamic has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.