In a sign that the healthcare industry may be on the cusp of a broad wave of consolidation, Tenet Healthcare Corp (NYSE:THC) recently announced that it would buy hospital company Vanguard Health Systems, Inc. (NYSE:VHS) in a deal with an aggregate value of $4.3 billion. The all-cash transaction would represent one of the largest health system mergers in recent memory and could pave the way for additional moves by similar American companies.
At first glance, it appears that Tenet Healthcare Corp (NYSE:THC) is paying a healthy premium for Vanguard Health Systems, Inc. (NYSE:VHS): Its offer price exceeds Vanguard’s pre-announcement value by about 70 percent and seems designed to ward off challenges from competing firms. However, the deal has attracted the attention of some shareholder-rights firms and may need to clear some steep legal hurdles before closing. If everything goes according to plan, Vanguard and Tenet should merge at some point in late 2013 or early 2014.
The American healthcare industry is highly fragmented. For various reasons, it appears to be populated by a vast array of small and medium-sized companies that operate in fairly well-defined geographical areas. Although this has begun to change, the industry remains somewhat behind the times. Accordingly, it would be fitting to compare Vanguard Health Systems, Inc. (NYSE:VHS) with cross-town rival HCA Holdings Inc (NYSE:HCA).
Vanguard is the smallest of the three firms by a massive margin. Even after Tenet Healthcare Corp (NYSE:THC)’s offer, the company has a market capitalization of just $1.6 billion. By comparison, Tenet has a market cap of around $4.6 billion. Much larger HCA is valued near $16.5 billion. This significant size discrepancy is reflected in these companies’ revenue figures as well: In 2012, Vanguard Health Systems, Inc. (NYSE:VHS) notched a narrow $65 million profit on revenues of just under $6 billion. For its part, Tenet managed an even more narrow profit of $42 million on revenues of $9.2 billion. With a profit of $1.4 billion on a total take of $33 billion, HCA Holdings Inc (NYSE:HCA) was the clear winner in this department.
Despite their apparent shortcomings, Tenet Healthcare Corp (NYSE:THC) and Vanguard are more expensive than HCA. In Vanguard Health Systems, Inc. (NYSE:VHS)’s case, a forward P/E of nearly 26 can be explained by Tenet’s seemingly generous buyout offer. Although Tenet’s forward P/E of 12.4 seems slightly high for a company that broke even last year, it is roughly in line with other healthcare firms. Meanwhile, HCA Holdings Inc (NYSE:HCA) has a forward P/E of less than 10.
How the Deal Is Structured
The terms of this deal are straightforward. Tenet Healthcare Corp (NYSE:THC) will issue cash payments of $21 per share to each Vanguard Health Systems, Inc. (NYSE:VHS) shareholder on the deal’s yet-to-be-determined closing date. It will also assume Vanguard’s hefty debt burden of about $2.5 billion. Between its cash payment of $1.8 billion and its debt assumption of $2.5 billion, Tenet will take a balance-sheet hit of roughly $4.3 billion on this transaction.
At Vanguard Health Systems, Inc. (NYSE:VHS)’s current stock price of $20.70, this transaction does offer a small but meaningful arbitrage premium of about 1.5 percent. Since this figure looks likely to fluctuate in the weeks and months ahead, the situation could provide short-term traders with repeated profit opportunities. Enterprising investors should look to buy Vanguard on price dips and sell near $21 per share.
Synergies and Other Benefits
The merger between Tenet Healthcare Corp (NYSE:THC) and Vanguard offers several important benefits. For starters, it will create a larger company that can compete with much larger firms like HCA Holdings Inc (NYSE:HCA) on somewhat equal footing. Tenet and Vanguard also have strong footholds in the southern United States. This deal will strengthen this regional presence and create additional economies of scale. Further, Tenet has recently found some success in its attempts to reduce costly inpatient admissions and increase traffic at its outpatient centers. The combined company may be able to accelerate these efforts and boost its profitability.