Tenet Healthcare - Acquisition Of Vanguard Health Creates Shareholder Value

| About: Tenet Healthcare (THC)

Shares of Vanguard Health Systems (NYSE:VHS) are spiking upward in Monday's trading session after the company agreed to sell itself to Tenet Healthcare Company (NYSE:THC).

The deal creates a lot of instant value for shareholders in Vanguard Health given the sizable premium, but could create even more value for shareholders in Tenet Healthcare in the long run. The company is well positioned to benefit from the Affordable Care Act going forward.

The Deal

Vanguard Health Systems announced that it has signed a definitive agreement under which the company has agreed to sell itself to Tenet in a $4.3 billion deal.

Tenet will pay $21 per share in cash for Vanguard's shares and assume another $2.5 billion in debt in an attempt to further boost the company's footprint. The offer is quite generous, as it represents an almost 70% premium compared to Friday's closing price.

Still the offer for Vanguard at $21 per share, only represents a $3 premium compared to the company's public offering which took place as recent as 2011.

Tenet is hoping to ride the benefits from the Affordable Care Act, by boosting its ownership to 79 hospitals and 157 outpatient facilities across the United Sates.

Tenet's CEO Trever Fetter commented on the rationale behind the deal, "This unique strategic transaction will bring together organizations that share a common commitment to providing high quality care and create significant new growth prospects for Tenet. This acquisition will take Tenet into new geographic markets, expand the breadth of our service offerings, diversify our earnings sources and increase the benefits we expect to realize under healthcare reform."

For the year ending on June 2012, Vanguard generated annual revenues of $5.95 billion on which the company reported a $57.3 million profit. The equity portion of the deal values Vanguard at 0.3 times annual revenues and 31-32 times annual earnings.

Tenet is hopeful that it can create a lot of value on the back of expected synergies of $100-$200 million per annum. Tenet expects to achieve notable labor and supply chain efficiencies. The deal has already been unanimously approved by the board of directors of both companies and will lead to an expected accretion in the first year after closing. Tenet expects to close the deal before the end of this calendar year.


Tenet ended its first quarter with $95 million in cash and equivalents. The company operates with $5.4 billion in total debt, for a heavy $5.3 billion net debt load. Financing does not appear to be an issue, Tenet has committed financing from Bank of America/Merrill Lynch (NYSE:BAC) in place.

Over the past year, Tenet has generated annual revenues of $9.12 billion, up 5.4% on the year before. Net income almost doubled to $152 million.

Trading around $44 per share, the market values Tenet at $4.4 billion. This values Tenet's operation at 0.5 times annual revenues and 28-29 times annual earnings.

Currently the company does not pay a dividend.

Some Historical Perspective

Shareholders in Tenet have seen very poor returns over the past decade. Shares slumped from levels in the $60s back in 2003 to lows of $5 during the crisis of 2009. Shares have recovered and stabilized around the $20 mark in the year's following, and have doubled since the autumn of last year to levels in their low forties.

Between 2009 and 2012, Tenet has increased its cumulative revenues by 10% to $9.1 billion. Net income fell from $187 million to $152 million in the meantime.

Investment Thesis

Investors are pleased with the deal which Tenet has made, and it increases its annual revenues by two-thirds. The $1.8 billion equity portion of the deal, values Vanguard Health at 0.3 times annual revenues and 31-32 times annual earnings. This is after paying a 70% premium for the shares.

Tenet itself trades at roughly 0.5 times revenues, but is slightly more profitable, trading at 28-29 times annual earnings. Assuming the midpoint of the synergy estimates of $100-$200 million, and statutory tax rates, annual earnings could increase by $100 million as a result of the deal. This values Vanguard Health at pro-forma 12 times annual earnings. Based on these metrics, the deal seems really favorable, although the net debt position will increase towards $10 billion, which is a bit steep.

Combined, both firms will generate annual revenues of $15 billion, report earnings of $200 million, and could see earnings increase toward $300 million factoring in the synergy estimates. All this values Tenet at $4.5 billion, or at 0.3 times annual revenues and 15 times earnings. Earnings could increase going forward as a result of the Affordable Care Act, while the debt position is a concern.

Under the Act more Americans will be covered under medical insurance, which is great news for Tenet. Not only will this result in a greater potential market, it will eliminate the bad new publicity of charity care. More importantly, it will eliminate or drastically reduce uncompensated care and unpaid bills, all of which has a positive impact on earnings.

All in all, it is easy to see why investors in Tenet applaud the deal despite the steep premium. Shares traded with gains of 5% halfway during the trading session, after peaking at $46 per share. The valuation remains appealing, with the Affordable Care Act approaching, although the debt position is a slight worry.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.