Magellan debt rating lowered to B-minus

Downgrade by S&P is 2nd in 3 months for struggling insurer

August 20, 2002|By M. William Salganik | M. William Salganik,SUN STAFF

Standard & Poor's cut its debt rating for Magellan Health Services Inc. yesterday - its second downgrade in three months - lowering the company's ratings from B to B-minus.

Last week, the Columbia-based mental-health insurer reported earnings below analysts' estimates for the quarter that ended June 30, reduced its earnings guidance for the current quarter and said it needs to restructure its debt to avoid falling out of compliance with its loan agreements.

Melissa Rose, vice president of investor relations for Magellan, said the company was "not surprised by the lowered ratings" since S&P had indicated there could be a further downgrade if Magellan's performance did not improve. Rose said Magellan is continuing with its efforts to raise prices to cover higher costs of delivering care and to reduce expenses.

In its announcement of the ratings cut yesterday, S&P said it had reviewed the company's efforts in the two months since it lowered Magellan's rating from B-plus to B.

"Although the company appears to be making some progress in these initiatives, the time elapsed since June 25, combined with Magellan's overall financial profile, as indicated in its latest quarterly results, has led to these actions," Charles Titterton, S&P's analyst, wrote in his report.

Rose said, as the company did last week in its earnings release, that Magellan is negotiating with its lenders. Magellan's agreements specify that it needs to have debt no higher than five times annual earnings by Sept. 30.

Susannah Gray, a debt analyst for Merrill Lynch& Co. Inc., issued a research report yesterday projecting that the debt-to-earnings ratio then would be 5.6. Rose said those covenants were negotiated when Magellan had several others lines of business expected to contribute to earnings. Some of those businesses failed, and one was sold, leaving Magellan with less cash flow.

Its debt, about $1 billion, was built up in acquiring several rivals, making Magellan, with 68 million members, by far the country's largest mental-health insurer.

In her report, Gray said, "While we are confident in the long-term viability of Magellan, we are increasingly uncomfortable with its near-term prospects." In an interview, she said, "That's a polite way of saying we think this company has a reason to exist, but its balance sheet is in the wrong ZIP code."

She said lenders were likely to amend the loan agreements, heading off a potential short-term crisis, but that recovery could be slow. While care costs are rising now, she pointed out, "given that only a third of its contracts renew each year ... price increases may be difficult to achieve quickly."

Also, she added, up-and-down performance over the past few years would make investors slow to respond to signs of recovery. "It leads to investor fatigue," she said. "People have seen this movie before, and they know that in the end, the boat sinks."

Magellan shares fell 3 cents to 92 cents yesterday.

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