Tenet to Acquire Vanguard in Surprise $4.3B Deal

The deal, when it closes, will give Tenet a footprint in 30 markets across 16 states. Charlie Martin, Vanguard's founder, chairman and CEO, will join Tenet's board of directors, and Keith Pitts, Vanguard's vice chairman, will serve Tenet as vice chairman.

Tenet Healthcare Corp. jolted the hospital industry this week with the surprise announcement that it will acquire smaller rival Vanguard Health System in a deal the two for-profit hospitals chains valued at $4.3 billion.

This latest high-profile consolidation in the hospital industry is expected to be finalized by the end of this year, just as millions of people gain health insurance under the Patient Protection and Affordable Care Act.

"The acquisition of Vanguard significantly increases our scale and diversifies our geographic footprint increasing our hospital and outpatient facilities by 61% and 25% respectively," Trevor Fetter, president and CEO of Dallas-based Tenet said during a Monday conference call with analysts.

Fetter said that with the acquisition of Vanguard, Tenet "will go from 49 hospitals and 126 outpatient centers serving 24 markets across 11 states to 79 hospitals and 157 outpatient centers in 30 markets across 16 states."

"This acquisition will create a broader platform across which we can apply our skills is revenue cycle services, cost management, and quality improvement as well as our clinical integration and network development strategies," he says.

"Significantly, it enhances our growth opportunities. Tenet's strategic priorities have always placed value on the creation of leadership positions in our markets. We will now be No. 1 or No. 2 in 19 key markets. It is important to note that Tenet and Vanguard serve totally distinct markets with essentially no overlap. We are excited to add clear leadership positions it the growing and highly attractive San Antonio and South Texas markets, two of the crown jewels in Vanguard's portfolio."

Under the definitive agreement reached by the two chains, Tenet will pay $21 per share in the all-cash transaction, which includes the assumption of $2.5 billion in Vanguard debt, which Tenet will refinance. The $21-a-share payout represents a premium of 70% and is the highest price for the stock since Vanguard's initial public offering in 2011.

Tenet says it has already identified at least $100 million to $200 million annually in savings with the acquisition. The deal was unanimously approved by the boards at both chains,

Investors responded favorably to the news. On an otherwise dour day on Wall Street, Nashville-based Vanguard saw its share prices soar by more than 67% for a 52-week high before closing at $20.70, just below the Tenet payout. Tenet shares rose 4.5% and closed at $43.73.

Analysts were caught off guard.

"Most of the M&A talk lately has been around names like HMA, so this was a surprise," said Joe France, healthcare analyst with Cantor Fitzgerald.

France says Vanguard was not necessarily on the radar screens for an acquisition because of its 2010 acquisition of Detroit Medical Center. "The appetite for an acquisition that includes that, which is about one third of their revenue, is fairly limited," he said.

"For a company like Tenet which has large urban medical centers it's a promising transaction because if it is successful—and there are reasons to believe that it has already been successful—then they can replicate that in other markets across the country and that opens up a whole new opportunity. This is something like an HCA might do in Kansas City or Colorado, but it is not something that has been done by most of the other hospital chains. But Tenet has a lot of experience historically in taking large hospitals and making them successful. Obviously Detroit Medical Center is a much bigger undertaking but I think they believe they can do it or they wouldn't have made this offer."

Fetter, in an interview Monday with CNBC, called Detroit "an interesting market obviously."

"It is a three-way tie for No. 1 in market area and Vanguard is very well positioned in Detroit. They have high-quality assets with a great reputation. I think post the transaction revenues from Detroit will only be about 11% of Tenet's combined revenues, so we see big opportunities there," he said.

"They have made very substantial investments that in the market that have yet to generate earnings, hospitals under construction and expansion there. We're looking forward to being state of Michigan and operators in Detroit."

When the deal closes, Charlie Martin, Vanguard's founder, chairman and CEO, will join Tenet's board of directors, and Keith Pitts, Vanguard's vice chairman, will serve Tenet as vice chairman. Martin has a 4.1% stake in Vanguard, which was founded in 1997. "We see the opportunity to recruit and retain Vanguard's operational and corporate talent as a real plus in this acquisition and we will maintain a presence in Nashville," Fetter said in the conference call.

Joe Lupica, chairman Denver-based Newpoint Healthcare Advisors, says the roles at Tenet for Martin and Pitts will not be mere sinecure.

"Charlie is nobody's prop. Charlie is one of the most feverishly brilliant thinkers in the business," Lupica says. "Keith is a brilliant operator and relationship builder with communities. That is important in this industry. If you are coming to town and you are a bad apple, you are going to have a hard time convincing the community to entrust their hospital to you. The question is, are they going to stay."

Adam Powell, a healthcare economist and president of Boston-based Payer+Provider Syndicate, calls the acquisition "a clear win for Vanguard investors; time will tell whether it will be equally advantageous for Tenet investors."

"The additional scale and experience with business outsourcing offered by Tenet has the potential to lower costs within the Vanguard system," Powell says. "The two companies have a partial geographic overlap, so the merger offers both geographic expansion, and in some cases, greater market power."

The acquisition is expected to be finalized by the end of 2013, just as millions of people are expected to become insured either through Medicaid expansion or health insurance exchanges provided under the Patient Protection and Affordable Care Act.

With that in mind, analyst Allan Baumgarten said in an email exchange that Vanguard was an appealing takeover target because of its "broader experience and assets in operating managed care plans and Accountable Care Organizations."

"It is unique among investor-owned provider systems in that regard," Baumgarten says. "Vanguard has large Medicaid (Phoenix Health Plan) and Medicare (Abrazo Advantage Health Plan) HMOs in the Phoenix area. In 2012, it acquired ProCare in Detroit, a small Medicaid HMO (less than 2,200 members), with an eye toward growing its share of the Michigan market for Medicaid managed care. Further, two Vanguard divisions are in the forefront of Medicare ACO development. In Michigan, the Vanguard-owned Detroit Medical Center formed Michigan Pioneer ACO, one of the original class of risk-sharing ACOs. In Illinois, some of the Vanguard hospitals and their physicians have established Chicago Health System, a Medicare shared savings program ACO."

Tenet management apparently is not overly concerned with Texas Gov. Rick Perry's bar-the-door refusal to expand Medicaid coverage. "The State of Texas has roughly 30% of its residents not covered by insurance today," Fetter told CNBC.

"Eventually we believe those residents will be covered by one form of insurance or another, and that will create substantial growth opportunities for hospital operators in Texas and very materially Vanguard's portfolio is located in the high growing markets of San Antonio and South Texas, particularly Harlingen and Brownsville. It is very appealing to us. We have a strong presence in Texas already, and together we will nearly double our revenues in the state."

Fetter told CNBC that the Vanguard acquisition "marks a turning point for the company in which we'll be more aggressive in acquisitions."

"We have been building our outpatient portfolio. We have doubled that through acquisitions in the last few years, and we have been building our services portfolio through acquisitions," Fetter said. "This is the first big acquisition we have done in a very long time in acute care hospitals. It will not be the last. One of the skills that Vanguard brings to the table is that they're known as a very good acquirer and partner to not-for-profit health systems and so I look forward to expanded acquisition pipeline in the acute care business."