Fitch Affirms DaVita Inc.'s IDR at 'BB-'; Outlook Stable

--The historically acquisitive nature of the company's operations and management's willingness to increase debt leverage, despite recent conservatism;

--DaVita's adequate liquidity position, good financial flexibility, and ability to consistently generate meaningful free cash flow; and

--Long-term growth potential that is largely unaffected by healthcare reform.

NEAR-TERM POTENTIAL FOR MARGIN PRESSURE, NEW BUNDLING RULE:

On July 23, 2010, The Centers for Medicaid and Medicare Services (CMS) issued its final rule outlining the terms of its new bundled Medicare End Stage Renal Disease (ESRD) prospective payment system (PPS). This ruling will take effect Jan. 1, 2011. Most significantly, the new bundling rule brings injectable drugs, including erythropoietin stimulating agents (ESAs), into the bundle. Medicare currently reimburses ESRD treatment providers for these drugs on a per unit basis, outside of the bundle. Fitch notes that ESAs account for approximately 60% of separately billable services and 25% of the total payment for ESRD services.

Top-line and margin pressure from the new bundling system is probable for dialysis providers, as CMS estimates that the 2011 base rate per dialysis treatment will reimburse large dialysis organizations at a level 3.7% lower than that at which the current ESRD reimbursement system would have in 2011. Fitch believes that DaVita can effectively mitigate this revenue pressure by using its large scale and low operating leverage to manage costs and to negotiate pricing for the products and services it uses, thereby increasing profitability within the bundle.

HISTORICALLY ACQUISITIVE OPERATIONS:

The company has been operating in a relatively conservative manner due to several factors, including some uncertainty surrounding the industry's operating and financial outlook due to healthcare reform and the pending switch to bundled Medicare reimbursement for dialysis treatment. Although DaVita has historically been highly acquisitive, this uncertainty, combined with recently high asset valuations of potential targets, has somewhat curtailed M&A activity.

Gross leverage for the latest 12-month (LTM) period ending June 30, 2010 was 2.74 times (x) (2.27x on a net leverage basis) - considerably below the company's stated net leverage target range of 3.0x to 3.5x and relatively low for the current 'BB-' rating category. Fitch expects gross debt leverage to hold relatively steady between 2.6x and 2.8x for the year ending Dec. 31, 2010 before increasing to within the lower end of the company's target range in the medium term. Furthermore, Fitch anticipates that management will manage acquisition activity and its capital structure more aggressively now that there is incremental clarity with respect to Medicare reimbursement and, to a lesser degree, healthcare reform.

CONSISTENT FCF, SOLID LIQUIDITY, AND GOOD FINANCIAL FLEXIBILITY:

Free cash flow (FCF) for the LTM period ending June 30, 2010 was approx. $642 million, significantly higher than the $392 million for the year ended Dec. 31, 2009. Increased FCF has been supported almost entirely by positive working capital trends, including an impact on cash flow of $142 million from working capital in the second quarter of 2010 alone. Fitch expects DaVita to generate between $300 and $400 million in FCF for the year ending Dec. 31, 2010. Liquidity at June 30, 2010 was comprised of $597 million in cash, cash equivalents, and short-term investments as well as $198 million of availability under the company's $250 million secured revolving credit facility (net of approx. $52 million of outstanding letters of credit) which matures in October 2012.

DaVita has good financial flexibility as a result of relatively low fixed costs (approximately 35% of total) and a high percentage of total capital expenditures that are discretionary. Margin compression from government reimbursement pressure has been mitigated by sales growth and fairly good SG&A control, resulting in relatively dependable cash flow generation.

Fitch expects DaVita to deploy cash using the following priorities:

--Acquisitions: Current pricing has been somewhat prohibitive as of late.

--Share repurchases: $100 million was repurchased in the first six months of 2010, and $400 million remains under the company's current, non-expiring authorization.

--Build cash: Historically, acquisitions have been financed with cash on hand.

--Debt reduction: DaVita pays relatively low interest rates on its outstanding debt, so there is not a big rush to pay debt ahead of its due date.

LONG-TERM GROWTH POTENTIAL LARGELY UNAFFECTED BY HEALTHCARE REFORM:

Unlike much of the rest of the healthcare industry, which is likely to see increased volumes and utilization, long-term growth potential for DaVita and its peers will be largely unaffected by healthcare reform, since Medicare already covers most Americans who require ESRD treatment. Nevertheless, Fitch expects 3% to 3.5% annual patient growth in the ESRD market, driven by an aging patient population and lifestyle trends that increase the incidence of diabetes and hypertension ? two leading causes of ESRD. Additionally, DaVita's advancements in dialysis techniques, technology, and supportive therapies could extend the lives of existing patients, further adding to the growth rate of this patient population. New technologies and supportive therapies could provide additional opportunities for revenue growth as well.

At June 30, 2010, DaVita had approximately $3.38 billion in outstanding debt, consisting of approximately $1.8 billion in term loans under its senior secured credit facility and $1.55 billion of senior and senior subordinated notes. Debt maturities are as follows:

Senior secured credit facility:

--$43.8 million due for the remainder of 2010;

--$65.6 million due in 2011;

--$1.7 billion due in 2012.

Senior unsecured notes:

--$700 million due 2013.

Senior subordinated notes:

--$850 million due 2015.

Management has publicly stated its intention to refinance, and potentially upsize, the company's existing credit facility in the next three to nine months. Fitch anticipates that the 2013 notes and possibly the 2015 notes as well will be refinanced at the same time as the bank facility.

Contact:

Primary Analyst
Megan Neuburger
Director
+1-212-908-0501
1 State Street Plaza
New York, NY 10004

Secondary Analyst
Bob Kirby, CFA
Director
+1-312-368-3147
Committee Chairperson

Michael Weaver
Managing Director
+1-312-368-3156

These rating actions reflect the application of Fitch's current criteria, which are available at '[ www.fitchratings.com ]' and specifically include the following:

--'Corporate Rating Methodology' (Aug. 13, 2010);

--'Liquidity Considerations for Corporate Issuers' (June 12, 2007).

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

Related Research:

--'Healthcare Stats Quarterly - First Quarter 2010' (June 17, 2010);

--'Healthcare Reform Update: Early Results' (May 12, 2010);

--'U.S. Healthcare: 2010 Credit Outlook' (Jan. 19, 2010).

Related Research:

Liquidity Considerations for Corporate Issuers

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666 ]

Corporate Rating Methodology

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646 ]

Healthcare Stats Quarterly -- First Quarter 2010

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=532689 ]

Healthcare Reform Update: Early Results

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=525945 ]

U.S. Healthcare: 2010 Credit Outlook

[ http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=496046 ]

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Contributing Sources

Market Wire

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Fitch Affirms DaVita Inc.'s IDR at 'BB-'; Outlook Stable