Fitch Affirms Universal Health Services at 'BB-'; Outlook Stable

Fitch Ratings has affirmed the ratings of Universal Health Services, Inc. (UHS) as follows:

--Issuer Default Rating at 'BB-';

--Senior secured bank facility at 'BB';

--Senior secured notes at 'BB';

--Senior unsecured notes at 'B+'.

The Rating Outlook is Stable. The ratings apply to approximately $3.78 billion of debt at June 30, 2011.

The ratings reflect the following key credit factors:

--UHS' has a history of strong acute care operations and leading market positions in regions with favorable demographics.

--Debt levels remain high subsequent to the acquisition of Psychiatric Solutions, Inc. (PSYS); but it has afforded the company increased scale in and exposure to the more profitable and stable behavioral health industry.

--Fitch expects relatively robust cash flows for UHS over the ratings horizon. This could contribute to reduced leverage if cash is directed to repaying debt.

--Strong pricing trends and a low cost inflation environment have offset the impact of weak acute care volume trends. However, Fitch does not believe these positive factors will show as prominently in the intermediate term.

--There is a good deal of uncertainty surrounding healthcare reform and budget debates at both the federal and state level. Fitch believes further cuts to government reimbursement are likely in the near-to-intermediate term, although it is unlikely that these cuts will be excessive.

GUIDELINES FOR FUTURE RATINGS ACTIONS

Maintenance of a 'BB-' IDR will require unadjusted debt-to-EBITDA generally maintained between 3.0 times (x) and 3.8x. Fitch acknowledges that UHS currently has a moderate degree of flexibility at its current ratings. A positive rating action could result from aggressive repayment of debt leading to leverage of around 3.0x over the next 6 - 12 months. Robust cash flows and evidence of success in integrating legacy PSYS operations would be expected to achieve a positive rating action.

HISTORICALLY STRONG ACUTE CARE BUSINESS EXPERIENCING VOLUME PRESSURE

UHS has historically maintained strong acute care operations with volume and pricing metrics often toward the upper end of the industry for the past several years. Weak volume growth across the industry has persisted for the last 10 or more quarters, with aggregate same-store (SS) admission growth of less than 0.5% in each quarter since 6/30/2009. UHS was able to maintain positive SS admissions growth until 3Q'10, mostly driven by favorable demographics in its most concentrated markets.

For the most recent quarter, UHS' acute care business saw an uncharacteristically steep year-over-year SS volume decline of 2.5% -- slightly below that of the Fitch-rated group average of -2.0%. Looking ahead, volumes will likely remain weak due to elevated unemployment and the postponement of elective procedures.

CREDIT PROFILE TRANSFORMATION, BOLSTERED BEHAVIORAL HEALTH BUSINESS FROM PSYS DEAL

Prior to the PSYS acquisition, UHS was the only Fitch-rated FPH with investment grade ratings. Leverage at 9/30/10 was about 1.4x. However, subsequent to the PSYS acquisition, total debt balances increased by more than four times and pro forma leverage increased to about 3.6x. Fitch sees limited opportunities in the current landscape for similarly leveraging transactions. Nevertheless, the PSYS deal illustrated management's willingness to stress its credit profile for an M&A opportunity.

Fitch does believe that UHS' purchase of PSYS was strategically sound and bodes well for longer-term growth prospects. Behavioral health revenues of $1.39 billion and $1.31 billion accounted for 30% and 25% of UHS' total revenues in 2010 and 2009, respectively. (Approximately 1.5 months of PSYS business was included in 2010 figures.) Fitch forecasts that behavioral health revenues will account for approximately 45% of total unadjusted net revenues, or $3.4 billion, in 2011. The behavioral health business is more profitable and generally more stable than acute care, and this business shift should continue to favorably impact UHS' overall margins and cash flows in the future.

ROBUST CASH FLOWS COULD RESULT IN ACCELERATED DEBT REPAYMENT

Despite weak macroeconomic conditions and poor volume metrics, UHS has experienced good growth in cash flows over the past few years. LTM FCF for UHS as of 6/30/11 was $366 million. This figure represents an increase of nearly 300% since the year ended 12/31/08. Contributing to this FCF growth is a paring back of capex ($380 million in 2009 compared to $250 million in the most recent LTM period) and good levels of operational cash flow.

Fitch expects UHS to produce FCF of around $400 million annually over the next three years. To the extent management prioritizes debt repayment as a use of cash, leverage could trend toward 3.0x by the end of 2011.

VOLUME AND PRICING PRESSURE WILL CONSTRAIN TOP-LINE GROWTH

High unemployment has caused uninsured admissions to rise in the mid-single digit range since 2009. Industry participants are beginning to report payor mix stabilization, as uninsured volume growth has seemingly plateaued for now. Nevertheless commercial volumes largely do not appear to have improved as of yet. Fitch expects unemployment and overall macroeconomic indicators to remain weak for much of the ratings horizon, which will likely hold down overall volume growth while continuing to cause the number of uninsured and Medicaid-covered admissions to remain elevated.

Maintenance of profitability through the trough of the economic recession was driven by good cost control and aided by low inflation in labor and supply costs. Fitch believes it is unlikely that operators will be able to continue to control costs to the same degree they have, especially if unemployment and other macroeconomic indicators remain weak for an extended period of time.

While strength in pricing has recently further supported the industry's profitability, pricing pressure will probably increase in the near-term. Fitch believes that decreased reimbursement from government payors is highly likely over the ratings horizon. A variety of factors are driving this dynamic including the implementation of healthcare reform as well as state and federal fiscal pressures. UHS is forecasting Medicaid reimbursement cuts of 3 - 4% in 2H'11.

LIQUIDITY IS ADEQUATE TO ADDRESS DEBT MATURITIES

As of June 30, 2011, UHS had adequate liquidity consisting of approximately $35 million in cash and equivalents and $590 million of availability under its $800 million revolver due 2015. The company's $240 million accounts receivable facility due 2013 was fully drawn. Fitch estimates UHS' debt maturities as follows: $224 million for the remainder of 2011; $48 million in 2012; $315 million in 2013; $79 million in 2014, $1.06 billion in 2015, and $2.05 billion thereafter. Current liquidity and forecasted FCF should be more than sufficient to cover debt maturities. Fitch expects that UHS will use proceeds from its revolver to refinance its $200 million secured notes issuance when it comes due in November 2011.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 16, 2010);

--'For Profit Hospital Insights: Changes in Bad Debt Reporting Will Improve Disclosure' (July 26, 2011);

--U.S. Healthcare Stats Quarterly - First-Quarter 2011 (June 16, 2011);

--'For Profit Hospital Industry Quarterly Diagnosis - First-Quarter 2011' (June 21, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

For Profit Hospital Insights: Changes in Bad Debt Reporting Will Improve Disclosure

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=646892

U.S. Healthcare Stats Quarterly -- Fourth-Quarter 2010

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=617166

For-Profit Hospital Industry Quarterly Diagnosis First-Quarter 2011

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=638785

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