Deutsche sees recovery rates for HealthSouth convertibles at zero to 30%

By Ronda Fears

Nashville, March 21 - Holders of HealthSouth Corp.'s 3.25% convertibles could see their recovery range from zero to as much as 30% in a liquidation scenario if the company files for bankruptcy in the wake of the alleged $1.4 billion fraud in its financials, according to estimates compiled by Deutsche Bank Securities Inc. convertible analysts.

"Bankruptcy is by no means the only option for HealthSouth. But with the maturity of $354.15 million in convertible paper in a matter of days and, we assume, no recourse to the revolving facility because of [covenant] language, a bankruptcy filing is clearly a distinct possibility," the analysts said in a report Friday.

"It is very important to stress that we cannot have confidence in any of the numbers in the 10Q [as a direct result of the allegations]. But as this is all we have, this is what we used for our analysis.

"We urge caution. If the asset values, as reported in the latest 10Q, are indeed largely fraudulent, the recovery rate on the 3.25% is more likely to be zero."

HealthSouth reported cash and equivalents in its Sept. 30 10Q of $389 million.

"We conclude that the most probable scenario sees the bond worth zero in a liquidation," said the analysts.

"However, we also show that with a 50% recovery rate on the company's plant, property and equipment line, the recovery value could be as high as 30."

Along with some $2.2 billion of senior unsecured debt, the analysts estimate there could be another $600 million of claims filed by other parties that would be lumped into the senior unsecured creditor pool.

There is some ambiguity as to the senior or subordination status of HealthSouth's $319 million of 10.75% senior subordinated notes due 2008 and the $354 million balance on the 3.25% subordinated convertible bonds due 2003, the analysts said.

The 3.25% was issued specifically to be pari passu to an old 9.5% 2001 senior subordinated issue, and the 10.75% was issued to refinance the old 9.5%, the analysts said.

"While the 3.25% and the new 10.75% carry the same ratings from the agencies, the subordination language in the 10.75% does not refer to the 3.25%. Logic might tell us that these two bonds are pari passu - but logic can sometimes be misleading in bankruptcy," they noted.

"For purposes of this analysis, we are treating these two bonds the same, but it is clear that in the event of a bankruptcy the 10.75% holders will try to prove that the 3.25% claim is subordinated to the 10.75%."

With a 50% recovery on HealthSouth's plant, property and equipment, estimated at $7.9 billion, the analysts calculate recovery for total senior unsecured claims would likely be 100%, or $2.8 billion, and subordinated claims - the 3.25% converts and 10.75% notes - would be just under 30%.

At 40% of plant, property and equipment, senior claims would get 96%, they said. Thus, subordinated claims would get nothing.

"Recall that we are not valuing the assets as a going concern," the analysts said.

"If HealthSouth were to file Chapter 11 and not be liquidated, holders of the subordinated debt would probably get paid in equity as the new HealthSouth emerges from bankruptcy, as may some of the senior debt in order to slim down the balance sheet.

"If such an 'equitization' of debt we to occur, we believe that it would come at a slightly higher, but not significantly higher, recovery percentage" for subordinated claims.

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