Rating Action Overview

• U.S. physician staffing and ambulatory services company Envision Healthcare Corp. completed a restructuring in April that involved moving 83% of its AmSurg business into an unrestricted subsidiary, raising $1.1 billion in first-lien debt at the unrestricted subsidiary, and issuing $1.3 billion in second-lien debt at the unrestricted subsidiary which it loaned back to the parent and used to complete the below par repurchase of roughly $1.9 billion in principal of existing term loans and unsecured debt at Envision.
• The restructuring has subordinated the claims of Envision's existing debt to the enterprise value of the transferred Amsurg business that represents a large portion of its consolidated value and significantly reduced the recovery prospects of its remaining secured debt, as evidenced by our revision of our recovery rating on this debt to '4' (30%-50%; rounded estimate: 30%) from '3' (50%-70%; rounded estimate: 50%). Further, as of now, the term loans and unsecured notes at Envision continue to trade at a significant discount to par, and the company has indicated that it may complete further open market repurchases of its existing debt in the future. We expect to maintain our 'D' rating on its existing term loans and unsecured notes until we believe that the likelihood of further below par repurchases of these debt instruments is remote.
• We upgraded our issuer credit rating on Envision to 'CCC' from 'SD' (selective default) and placed the rating on CreditWatch with negative implications.
• Our issue level rating on the company's $300 million revolving credit facility due in October 2023 is unchanged at 'CCC'.
• The CreditWatch with negative implications reflects the probability of a downgrade within the next 90 days if it appears inevitable that Envision will face a payment default or undertake additional below par debt repurchases or actions that we consider distressed.

Rating Action Rationale

Our 'CCC' issuer credit rating on Envision Healthcare Corp. reflects the very challenging operating environment within its physician services segment and our expectation the company will generate meaningful discretionary cash flow deficits over the next few years. We expect the combination of patient volume likely remaining below pre-pandemic levels and volatile, high labor costs, and payor pressure on rates will keep profitability weak within Envision's physician services segment. Although patient volume improved during 2021, we expect patient utilization of emergency rooms will differ compared to pre-pandemic utilization. Increasingly, patients with lower-acuity emergent needs are finding alternatives to the emergency room, including the greater use of virtual technology. Moreover, the Omicron surge added unanticipated pressure on visits. In our view, this shift in emergency service utilization and near-term volatility related to COVID-19 case surges create significant challenges for Envision's ability to efficiently manage clinical utilization. Furthermore, the company, like the rest of the health care industry, faces labor challenges requiring the use of more expensive locum and overtime labor. We expect these headwinds will remain in the near term, albeit not as pronounced as in January and February, and contribute to meaningfully weaker operating efficiency, profitability, and cash flow generation within its physician services segment than we previously expected.

We continue to view Envision's capital structure as unsustainable. On April 29, 2022, Envision issued new senior secured first- and second-lien debt at one of its subsidiaries (AmSurg LLC) and used the net proceeds of about $2.4 billion to provide the company with about $1 billion in additional liquidity and $1.3 billion to fund the negotiated open-market discounted repurchases of about $1.9 billion in legacy debt. The transaction resulted in an increase in consolidated gross debt of about $520 million and bolstered the company's unrestricted cash balance to about $1.2 billion. Despite this large cash injection, we believe Envision's capital structure remains unsustainable based on our expectation for annual discretionary cash flow deficits of $100 million to $300 million over the next couple of years, inclusive of the profitability weakness in the physician services segment, expected significant uses of working capital, increased capital expenditures to expand its ambulatory services business, and rising interest rates (just under 90% of the company's debt outstanding is based on a variable rate). Furthermore, an aggregate amount of about $744 million outstanding under Envision's ABL and revolving credit facilities comes due October 2023. We believe the company is likely to have a difficult time refinancing or repaying these obligations without an unforeseen positive development, thereby making a default scenario likely within the next 12 months in our view.

CreditWatch

The CreditWatch with negative implications reflects the probability of a downgrade within the next 90 days if it appears inevitable that Envision will face a payment default or undertake additional below par debt repurchases or other actions that we consider distressed, apart from its debt we currently rate 'D'.

Company Description

Envision is a national provider of physician-led services, ambulatory services, and post-acute services. The company is one of the largest providers of outsourced physician services to hospitals, ambulatory surgery centers, and other health care facilities, primarily in the areas of anesthesiology, radiology, women's and children's services, and emergency medicine. In 2021 the company generated about $7.3 billion of revenue (including grants), of which about 83% was from physician services and about 17% was from ambulatory services. It is also one of the largest owners and operators of ambulatory surgery centers in the U.S. based on total number of facilities (258). Envision was acquired by KKR in October 2018.

Liquidity

We view Envision's liquidity as less than adequate. This primarily reflects our view that the company is unlikely able to absorb low-probability adversities under its existing capital structure and that it lacks the standing in credit markets to warrant a stronger assessment. Furthermore, while we expect Envision's sources of cash to be sufficient to cover its uses over the next 12 months (starting immediately after the recent transaction), we believe the company will likely exhaust its available liquidity over the subsequent 6 months and be unable to repay its upcoming debt maturities.

Principal liquidity sources

• Unrestricted cash (excluding cash held at a joint venture or captive insurance entity) of about $1.2 billion following the restructuring transactions completed April 29, 2022; and
• Annual cash funds from operations (FFO) of at least $30 million.

Principal liquidity uses

• Working capital outflow of $150 million to $200 million over the next 12 months;
• Capital expenditures of $140 million to $160 million over the next 12 months;
• Annual distributions to noncontrolling interests of at least $200 million;
• At least $50 million per year to self-fund its malpractice insurance coverage;
• About $60 million in scheduled annual debt amortization; and
• $744 million outstanding under Envision's revolver and ABL facilities that mature Oct. 11, 2023

Covenants

Requirements

The existing term loans issued by Envision do not require the company to comply with financial maintenance covenants. However, the company is subject to a springing first-lien net leverage covenant of 8.75x when the revolver is more than 35% drawn. Currently, the $300 million revolving credit facility is fully drawn. The $550 million asset-based revolver is also subject to a springing financial covenant requiring the fixed charge coverage ratio not to exceed 1x when excess availability under the ABL facility is less than the greater of $55 million and 10.0% of the lesser of the then-applicable borrowing base and the then-total effective commitments under the facility. We believe there is about $444 million drawn under its $550 million ABL facility (not including about $106 million of outstanding letters of credit).

Compliance expectations

For the period ending March 31, 2022, Envision exceeded the maximum leverage covenant under its revolver. However, the company was able to obtain a waiver from its lenders, solely with respect to that period. Going forward, we believe the headroom under its covenants will be tight and could be breached again if our forecasted EBITDA were to decline by just 10%.

Issue Ratings - Recovery Analysis

Key analytical factors

• Our '4' recovery rating on the revolving credit facility indicates the expectation for average (30%-50%; rounded estimate: 30%) recovery in the event of default. The recovery prospects for this debt were significantly impaired by the April 2022 restructuring which transferred 83% of its ambulatory services business (and related collateral) to an unrestricted subsidiary (AmSurg LLC) that was subsequently levered by debt that we believe would fully absorb this entity's value in a default scenario. Further, while legacy debt at Envision (hereafter called RemainCo) was reduced by about $1.9 billion through the discounted repurchase transactions, consolidated debt increased and net claims against RemainCo were only reduced by about $600 million because of the $1.3 billion of intercompany debt that RemainCo now owes to AmSurg. The intercompany debt was structured to give AmSurg a pari passu first lien against RemainCo's assets.
• Following the restructuring, RemainCo's debt structure consists of a $550 million ABL facility (with about $440 million drawn), a $300 million revolving facility (fully drawn), $3.8 billion first-lien term loan B, $120 million incremental term loans, $981 million of unsecured notes, $1.3 billion in intercompany loans due to AmSurg, and about $12 million in ASC debt.
• At the unrestricted AmSurg LLC subsidiary, there is a $1.3 billion newly issued first-lien facility (including an undrawn $200 million delayed-draw term loan), a $1.3 billion second-lien facility, plus about $47 million in Ambulatory Surgery Center debt.
• Our simulated default scenario contemplates a default in the first half of 2023, due to liquidity and maturity pressures. We assume EBITDA at this point is roughly in line with the company's fixed-charge obligations, including debt service requirements and minimum capital expenditures.
• We believe Envision would remain a viable business and would reorganize rather than liquidate following a payment default. Consequently, we valued the company as a going concern.
• We assume the gross enterprise value of the company at default is split 60/40 between the restricted and unrestricted groups. The restricted group (RemainCo) comprises the physician services business and about 17% of the ambulatory services while the unrestricted group (AmSurg LLC) comprises about 83% of the ambulatory services business.
• For our recovery analysis, we assume the $300 million cash flow revolver is 100% drawn and the ABL facility is about $444 million drawn, reflecting current usage rates; mandatory principal amortization is made, up to the default year; and six months of accrued and unpaid interest on funded debt (in addition to accrued interest that is PIK on RemainCo's incremental term loan and AmSurg's second lien debt).
• We assume the ABL facility has a priority claim on working capital assets at RemainCo.
• We value the company using a 6x multiple on our projected emergence EBITDA, which is 0.5x above the standard multiple used for the health care services industry to reflect our view of Envision's relatively larger scale and better diversification compared to peers due to its ambulatory services business. However, given the complexity of the restructuring, we have assumed administrative expenses would absorb more value in a bankruptcy restructuring, so we've increased this estimate to 7% of gross enterprise value compared with our normal assumption of 5%.
• We note that further potential capital structure changes over the coming weeks or months could further shift debt amounts and relative priorities and that these changes could raise or lower our estimated recovery for Envision's secured claims. Potential changes include, but are not limited to, debt repurchases below par or the partial or full repayment of its intercompany loan.

Simulated default assumptions

• Simulated year of default: 2023
• EBITDA at emergence: $678 million
• EBITDA multiple: 6.0x
• LIBOR: 250 basis points

Simplified waterfall

• Gross enterprise value: $4.07 billion
• Net enterprise value (after 7% administrative costs): $3.78 billion
• Valuation split in % (Remainco/AmSurg LLC): 60%/40%
• Value available to RemainCo claims: $2.27 billion
• ABL priority lien: $453 million
• Total value available to RemainCo first-lien lenders: $1.81 billion
• Secured first-lien claims (includes revolver, term loans, and intercompany loans): $5.82 billion
• --Recovery expectations: 30%-50%; rounded estimate: 30%

Note: All debt amounts include six months of prepetition interest.

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings, Oct. 1, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

Ratings List