Report on Hospital Corporation of America Case

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Recommendations

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Recommendations on future strategy

HCA’s case fits perfectly into the BCG matrix (see Fig.1 below).

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Fig.1.

In the early 1970s, HCA was a question mark (high market growth rate, low relative market share). In order to increase its market share in the industry, it acquired existing hospitals and constructed several new hospital units increasing the number to 349 in 1981 as opposed to 48 in 1972. During this period, the hospital industry in general, grew a lot due to programs like Medicare and Medicaid which stimulated demand for hospital services and stabilizing the company’s revenue inflow.

From 1978 to 1981, HCA was a star (high market growth rate, high relative market share). It continued to acquire other proprietary hospital management companies and non-profit hospitals. HCA increased no. of hospitals from 112 to 349 during this period (an increase of more than 300%). During this period the no. of hospitals across US actually declined.

Beyond 1987, HCA should transition from a star to a cash cow (low market growth rate, high relative market share). Instead of acquiring other hospital management companies, HCA should improve or renovate its existing facilities and revamp the equipment and management system of the already acquired not-for-profit hospitals to reduce costs as well as expand its current services to include home health care and outpatient surgery to cater to a forecasted increase in demand. This is because expansion through acquisition of for-profit hospitals would run its course and construction of new hospitals or acquiring sick hospitals was not going to contribute to profits immediately. HCA should mature and become a cash cow by about 1987. At this stage, it is expected to incur sustainable capital expenditure. The company can be "milked" continuously from its existing operations and is expected to generate cash in excess of the amount required to maintain the business.

Another important goal would be to satisfy the quality image of the company in terms of bond rating and Management credentials. Even if they lose their A rating, all efforts should be made to regain it in consolidation phase i.e. when acquiring non-profit organisations.

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Recommendations on Asset Efficiency

HCA’s asset turnover has declined from 1.3 to 1.5 since its assets have increased at a rate faster than its revenue. HCA has acquired several old, out-dated assets which have not been able to generate revenue efficiently. Also accounts receivables have increased significantly due to poor customer base coming in from non-profit acquisitions. The company should consider renovating the buildings and revamping the equipment and management system to get things operational and resolve working capital management issues.

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Recommendations on Financial Goals:

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HCA’s main financial goal is to maintain return of equity of 17%. Last 2 years has seen this ratio in the range of 20-24% (exhibit 5). This goal is important so that shareholders will continue to invest in HCA since their required rate of return will be satisfied and can be achieved changing the debt ratio and the debt mix of the company. This will also help increase retained earnings and then help reduce large amounts of debt and interest expense in the coming year in the face of uncertainty that may arise as a result of changes to the federal reimbursement programs. Maintaining a dividend growth rate of 15% is another financial goal to consider. It is important to maintain dividends at a steady level as it sends out a positive signal to investors that the firms’ earnings are steady and investors can rely on company’s dividends as a source of fixed income.

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Recommendations on Funding needs

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HCA expects to incur capital expenditure of $575 million per year which is expected to grow at 20% per year for the next several years. Considering the recent reduction in net profit margin from 5.7% to 4.6% (Exhibit 5), the firm should maybe reconsider capital expenditure for the next 5 years because it will be increasingly difficult for revenue growth to keep up with this expenditure growth in the long run given the increasing outflows due to debt maturity from $34 Mn to $163 Mn in next 5 years (Exhibit 7). Capital expenditure is deferrable. Debt payments are obligatory. This does not mean that capital expenditure cannot be incurred; it is just that it cannot grow at an unsustainable rate. Dividends also impact on funding decisions. It is necessary to maintain dividends to improve our equity base. Any shortfall between capital expenditure and dividend payments and retained earnings can be funded by lower interest floating rate debt – term loan agreements. At the same time the firm should not consider issuing equity to fund its capital expenditure for several reasons. Firstly the firm would suffer from higher flotation costs by issuing equity compared to debt issues according to the Pecking Order Theory (Brealey, Myers, & Marcus, 2009). Also the firm has issued $286 million of convertible debentures which are most likely to be converted into shares when they are eligible for conversion at the prices of $62.30 and $43.50 (Exhibit 7) assuming HCA reaps the benefits of operating synergies from their acquisitions. Hence HCA does not want to have to service and pay dividends on more shares than what it already expects to have in the future which may end up in the firm cutting dividends per share. This could have detrimental consequences for the firm’s stock price.

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Interest coverage ratio and bond rating

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Interest coverage ratio is measure of a firm’s ability to meet its interest payments. HCA’s interest coverage ratio dropped from target 3 to 2.4 (lowest level since 1968). One direct implication of this was loss