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Morningstar | Despite Quarterly Volatility, We Think 2018 Was a Success for Tenet's New Management

No-moat Tenet finished 2018 on a solid note, with both revenue and EBITDA coming in modestly ahead of our expectations. As we suspected, management's initial 3%-5% guide for 2019 EBITDA growth presented in the third quarter proved too conservative, with its revised projections now implying 4%-7% improvement over 2018, consistent with our expectations. As we update and roll our model, we'll likely raise our fair value estimate by a high-single-digit percentage driven by the cash flows received since our last update and a modestly higher long-run outlook on profitability.

While there were bumps in the road for Tenet throughout 2018, we think the year was characterized by the substantial operational and strategic improvements put in place by Ron Rittenmeyer following his appointment as CEO in late 2017. Steady organic growth acceleration at both the firm's hospital and ambulatory operations, along with sizable cost savings realized at Tenet's Conifer business have led to consolidated performance that has been markedly improved versus the company's recent past. The achievement of $250 million run-rate cost savings by the fourth quarter sets the stage for improved value creation at the firm, and management's announcement of an additional $200 million targeted by next year drove the bulk of today's positive market reaction, in our view. We think there remains ample opportunity to improve the cost structure of the hospital operations, with management also targeting continued margin gains at Conifer.

Additionally, the company announced it entered an exclusivity agreement with an entity potentially interested in the firm's Conifer business. While not much has been disclosed, we're surprised to see progress on this front as we'd long believed the business would be a difficult asset to sell given its customer concentration. We'll see how this negotiation progresses over the coming months but expect a near-term conclusion to this long-running strategic evaluation.

While management's 2019 revenue outlook for the firm's ambulatory and hospital operations were in line with our views, Conifer came in modestly below our expectations. Customer losses attributable to both former Tenet facilities along with asset divestitures at third-party clients are expected to drive nearly $150 million in lost revenue, offset by growth in remaining channels. That said, continued cost reduction efforts at Conifer kept management's 2019 EBITDA guide for the segment in line with our estimates.

Finally, we're encouraged by the company's progress on tackling its sizable debt balance over the course of 2018. While management only repaid $150 million in outstanding principal, EBITDA growth drove its leverage ratio down by roughly 0.4 times to 5.8 times on a gross basis or 5.6 times net of cash. Depending on capital priorities, we think a mix of growth and debt reduction could result in net leverage nearing 5.2 times by the end of 2019 and below management's target of 5 times during 2020.