Debt strategy seems sound as dialysis firm recovers. (Corporate Foucs).

DAVITA Inc., the Torrance-based operator of kidney-dialysis centers, was once a broken company. Its return to financial health, underscored by its current Dutch tender offer to buy hack as much as $600 million of its stock, proves that with a change of management, anything's possible.

As recently as March 2000, shares of DaVita fell as low as $2.06 each. The company, then called Total Renal Care Holdings, was going through severe growing pains. Its acquisition of another competitor, called Renal Treatment Centers, had doubled the size of the company overnight, and the previous management team botched the integration.

"Their backoffice infrastructure essentially collapsed under the weight of the company," said Andreas Dirnagl, a Gerard Klauer Mattison analyst who was following the company at the time. 'They literally couldn't send out bills on time, their collections process fell apart - it was a pretty dire circumstance."

There was hope, but investors weren't yet convinced that a turnaround was under way. In October 1999, a new management team arrived, headed by Chairman and Chief Executive Kent Thiry, and proceeded to clean house. "They spent a whole lot of time and investment in systems and people to fix that back office," Dirnagl said.

The company recovered, and now it's generating strong cash flows. It's the second-largest operator of kidney dialysis centers in the country, one of four firms that dominate a majority of the market. The stock, meanwhile, is trading at a recent price of $24.90. A $10,000 investment in DaVita made at its lowest closing price, on March 23, 2000, is now worth more than $97,000; the same $10,000 invested in JDS Uniphase, to name one of the many high fliers of the time, would today be worth less than $450.

"Thiry has really done an excellent job of turning DaVita around' Dirnagl said.

Giving back to shareholders

Even more exceptional than the comeback is what DaVita's management plans to do next. They've taken the rare step of acknowledging that their cash flow would be better used in returning money to shareholders, via the buybacks, than pursuing new income streams.

"Our current assessment of industry growth prospects suggests that we will have more cash flow and debt capacity than high-return investment opportunities," Thiry said in a March 21 statement on the buyback.

DaVita has announced it will buy back up to 24 million of its common shares, for between $20 and $25 each. Under the Dutch auction process, shareholders indicate the lowest price they will accept in the range. The company will pay the lowest price it can to buy back a block of up to 24 million. All selling shareholders will receive the same price. If it buys all 24 million shares at $25 each, the buyback will cost DaVita about $600 million.

DaVita is also buying back about $225 million of high-yield 9 1/4 percent notes. The company will use bank debt to finance all of this, paying an interest rate of about 5.5 percent.

Taking an mare debt

The move does have its risks. DaVita will carry more debt coming out of this than it did before, perhaps $1.5 billion compared with just over $800 million. So if the company runs into problems down the road, the debt load may be a hindrance. (A competitor, Renal Care Group, has a similar financial profile, but is holding onto its cash.)

Nevertheless, said Jefferies & Co. analyst Andrew May, "I think it's the right move." The major players have consolidated much of the dialysis market, he said, so opportunities to buy more centers come up only occasionally.

At the same time, payment flows from the federal government, through Medicare, and from private payers such as health insurers, are pretty reliable. With reliable income streams, high levels of debt are reasonable. "There's definitely more risk in having that much more financial leverage, but I think it's a prudent use of the balance sheet" to increase shareholder returns, May said.

By using bank debt, DaVita has created a more flexible financial structure, said Dirnagl. It can use its cash flow - DaVita will generate about $375 million in earnings before interest, taxes, depreciation and amortization in 2002, he estimates - to pay down debt without penalties, or it can hold onto the cash for potential acquisitions when the time is right.

DaVita just hired an acquisitions vice president, but the lead time on these kinds of deals is 6 to 12 months at a minimum. In the meantime, by shrinking the equity base, DaVita can add up to 7 cents a share to quarterly earnings.

"DaVita has been out of the acquisitions market now for a number of years, but while you certainly want to get back into it, you want to prime the pump first," Dirnagl said.

[GRAPH OMITTED]

DaVita Inc.

               Stock Prices

April 3, 2001     $16.40
April 3, 2002     $25.07

Note: Table made from line graph
YEAR (Dec. 31)                  2001   2000

Revenue (billions)              $1.7   $1.5
Operating Expenses (billions)    1.3    1.3
Operating Income (billions)      318  174.7
Net Income (millions)          137.3   13.5
Earnings Per Share             $1.52  $0.16

Quarterly Net Income (millions)

SUMMARY

Business: Operator of kidney dialysis centers

Headquarters: Torrance

CEO: Kent Thiry

Market Cap: $2.1 billion Dividend Yield: N/A *

Total Liabilities: $1.2 billion

P/E Ratio: 18.7

Long-Term Debt: $811 million

* Da Vita Inc. does not pay dividends

RELATED ARTICLE: Magical Mystery Bonus Plan

CONTINENTAL Airlines Inc.'s chief executive, Gordon Bethune, elected after the Sept. 11 terrorist attacks to forego all compensation for the remainder of last year.

So how was it that Bethune received a $967,320 bonus, as revealed in the 2001 proxy statement that Continental released last month? And how was it that he also received a $2.3 million payout under a long-term incentive plan?

Well, the answer to the first question is that Continental, alone among the major airlines, pays bonuses quarterly. Bethune was able to get away scot-free for delivering a fourth-quarter loss of $3.81 a share.

Quarterly bonuses? Does any red-blooded American need an incentive to focus on a period so narrow as 90 days. Judging by a search of hundreds of U.S. companies' proxies, it hardly appears that way. A review revealed only 11 cases in which companies had quarterly bonus programs for top executives. Otherwise, bonuses are predicated on the results of an entire year.

All of the companies making quarterly payments have highly volatile earnings. Of course, that's precisely where paying the bonuses could help protect executives' income, even though it doesn't do anything for shareholders.

Continental's plan applies to about 20 top executives, said Ned Walker, a spokesman for the Houston-based airline. Managers who didn't qualify for these bonuses nonetheless received some bonus money for 2001, in part because their payments were predicated on personal performance.

The plan's participants received bonuses for the first three quarters, including the third, when the company showed a loss of $1.76 a share. The cumulative loss during the three quarters was 86 cents a share.

Apologists will doubtless retort that they couldn't be held responsible for Sept. 11.

Then again, how responsible could Bethune have been for his company's $342 million profit for 2000, when he received a bonus of $2.1 million? U.S. airlines were benefiting back then from a stillbooming American economy.

Now to the second question: the payment under the long-term incentive plan, designed to reward executive performance during three-year, overlap- ping cycles. Performance is primarily defined as earnings before interest, taxes, depreciation and aircraft rentals compared with other airlines.

When Continental started this plan in 2000, the company inaugurated two transition cycles. The first covered only 2000, making a mockery of the plan's long-term intent. For that cycle, Bethune received $781 ,87.5, equal to one-third of the payout he would have received for a full three-year period.

The second transition cycle covered two years, 2000 and 2001. Bethune was to. receive a payout equal to two-thirds of his normal payout. His payout was $2.3 million, or precisely triple the amount from the first cycle.

This suggests Continental's board concluded his performance was better during the two-year period than during the one-year period. That's hard to swallow, given that the airline earned $5.45 a share in 2000 and lost $1.72 a share in 2001.

- Graef Crystal, Bloomberg News

Financial Editor Anthony Palazzo can be reached at 323-549-5225, ext. 224, or at [e-mail].