Hospital of America

As of Jan 1982, Hospital Corporation of American (HCA) is facing a very complex situation that isdetrimental for its future. The HCA's ratio of debt to total capital approached 70% - well above its target ratio of 60%, and the ratio is expected to be even higher 75-80% with the current rate of growth. In addition, HCA's interest coverage had dropped to 2.4 times (target 3.0 times), the lowest level since 1968. While many investors are optimistic and justified on HCA's more aggressive use of leverage, others were concerned that HCA's A bond rating would be at risk. Should HCA's bond rating is downgraded; HCA will be facing not only the mounting interest expenses but also an inaccessible capital market. Nevertheless, we still see HCA's performance as phenomenal, and HCA's business strategy as solid as to date. The following is an overview of HCA's recent financial performance:

1980 1981

Revenues: $2,406,472 $1,428,541 (~68% increase)

($000)

Comparative Growth rates 1976-1981

HCA; Humana Inc; AMI; NME; Lifemark (left to right)

Revenues 35.3% 41.1% 31.2% 47.0% 31.0%

Net income 32.4% 54.6% 46.1% 52.7% 40.9%

Total assets 34.2% 30.0% 22.7% 34.3% 39.7%

Hospitals in operation 30.1% 6.8% 13.4% 18.7% 11.7%

Historically, HCA maintained its growth through four sources: acquisition, construction of new hospitals, expansion of services, and the signing of new management contracts. However, we anticipate a series of internal and external changing factors that will force HCA to re-align the current business and financial strategy. In helping our clients to do so, we utilized the renowned industry analysis- Porter Five Force.

1. Bargaining Power of Suppliers (Medium→High)

Based on HCA's supplied industry report, the existing and potential suppliers include the followings:

1. Other hospital management companies

2. The remaining hospitals in U.S (including non-profit county, municipal, and religious-order hospitals)

3. Hospitals around the world

Through a thorough research and assessment of the suppliers nationwide and internationally, we find the bargaining power of suppliers to be medium→high.

First of all, the antitrust law would limit the further acquisition of other hospital management companies and specifically for the large chains including HCA. The limitation will seriously frustrate HCA as well the other big chains, as HCA's growth and stock performance is highly dependent on the continuous growth. The frustration will somehow make our client desperate to look into the second tier market that includes non-profit county, municipal and religious order hospitals, and as well as the international market. Although the aforementioned targets may help HCA with its growth (long-term potentially), the burdens, costs, and externalities may slow down the short-term growth that is a must for the company. Also, the desperation, faced by HCA, will shift the bargaining power to each potential supplier and cause some lower-than-average NPV deals.

2. Threat of New Entrants (Low→Medium)

The "certificates of need" have been a requirement for new hospital construction. The requirement was a bureaucratic headache for hospitals; it somehow has protected HCA from new entrant into its territory. However, the protection would be removed under proposals to eliminate the certificates. On one end, the elimination will stimulate rapid expansion into the nationwide territories, and this is beneficial for HCA to tap into the areas that it was unable to. On the other hand, HCA will be facing competing hospital into HCA's own territory and the possibility of service duplications. The new situation will, expected by many, further worsen the average occupation rate of all U.S hospitals. The rate is a very important indication of future revenue growth for HCA.

3. Threat of Substitutes (Medium→High)

Going off the threats of new entrants we just discussed, we see the increasing threat of substitutes in terms of service duplications. Although the increased threat is not materialized under a immediate term, the new hospital(s), due to the deregulation, will pose increasing threat to HCA's operation and profitability in the near future.

4. Bargaining power of Buyers (High)

The above demonstrates a ten-year summary for HCA's sources of revenue (Exhibit 4). We can see that Medicare/Medicaid has been a very stable revenue source for HCA. Also, the government is considering a proposal for "prospective reimbursement", in which capital costs would be prospectively set along with the other costs of providing services. The possible implication for HCA is that it would no longer be able to count on recouping the full amount of their allowable interest expense from the federal government (permitted by the existing program). There is another proposed approach in which interest expenses will continued to be paid retrospectively, while the return on equity provisions (under current program) will be dropped altogether. Regardless which outcome the government will eventually implement, HCA will face greater pressure to maintain an adequate return on capital, and greater volatility in hospital revenues and earnings. Combining with the decreasing national occupancy rate and a highly aggressive capital structure, HCA has to breakthrough somewhere to continue its growth, or else it has to slow down and become more focused on the profitability.

5. Industry rivalry (Low)

Based on the HCA's historical business performance, we can see that HCA has successfully built up its geographic penetration and economies of scale. The hospital business is extremely capital intensive and lengthy yield period. HCA's available capital and value-added assets will ensure the company