Texas merger would create state's largest nonprofit hospital outfit

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DALLAS — The merger of Texas nonprofit health care giants Baylor Scott & White Health and Memorial Hermann would create the state’s largest hospital operator with more than $5.5 billion of debt in a rapidly consolidating market.

“If the merger closes, the combined entity — which has not yet been named — would have total annual operating revenue near $15 billion, including close to $1 billion in premium revenue,” S&P Global Ratings analyst Patrick Zagar said. “In our view, this scale would likely create additional leverage for the system in a number of areas, as well as allow for other operational and clinical efficiencies.”

S&P plans to wait for the merger to be completed before considering any ratings action, Zagar said.

The two health care chains announced plans to merge Oct. 1 in a plan to improve their competitive posture in a state with the highest rate of uninsured residents.

Memorial Hermann is the largest in Houston, while Baylor Scott & White is the largest in the Dallas area.

The Baylor and Scott & White health systems, with more than $6 billion of combined revenues, merged in 2013. That provider also has a major presence in Central Texas, where Scott & White had its flagship hospital in Temple.

"This is about two mission-driven organizations — both committed to making safe, high-quality health care more convenient and affordable — building something transformative together," said Jim Hinton, chief executive of Baylor Scott & White Health. "We must lead the change in our industry, while insisting we continue to fulfill our unwavering commitments to meeting the needs of all Texans."

The merger is expected to produce cost savings through sharing of expertise, collaborations on technology and increased buying power and efficiency. Top executives noted that the two systems combined have nearly 5,000 current job openings. However, Memorial Hermann laid off 460 employees in 2017, citing uncertainty in the health care market.

Mergers on the scale of Baylor Scott & White and Memorial Hermann must pass a series of regulatory hurdles while also promoting buy-in from nurses, doctors, donors and other stakeholders.

Catholic Health Initiatives, which acquired St. Luke's Healthcare in Houston in a $2 billion deal in 2013, is hoping to complete a merger with California-based Dignity Health by December, a year after the two health care giants signed an agreement to combine forces. If completed, it would become the nation’s largest nonprofit health system with annual revenues of almost $29 billion.

Baylor Scott & White Health began with total assets of $7.7 billion, 43 hospitals, more than 500 patient care sites, more than 6,000 affiliated physicians, and 34,000 employees.

In January 2014, the Baylor College of Medicine and CHI St. Luke’s Health agreed to be joint owners of St. Luke's Medical Center, the teaching hospital for Baylor. The hospital in Houston’s sprawling Texas Medical Center was renamed as the Baylor St. Luke's Medical Center.

The original Baylor College of Medicine Medical Center building on the McNair campus also became part of the joint ownership.

Baylor Scott & White Health became the largest not-for-profit health system in Texas, with 48 hospitals located throughout north and central Texas.

Memorial Hermann is a 19-hospital health system that operates in and around the Houston metropolitan area, with its flagship hospital located in the Texas Medical Center. Memorial Hermann is the market share leader within its growing Houston service area.

The two systems are targeting a definitive agreement in the first quarter of calendar 2019, with a potential close date in summer 2019.

"Together, we believe we will be able to accelerate our commitments to make care more consumer centric, grow our capabilities to manage the health of populations, and bend the unsustainable health care cost curve in the state," said Chuck Stokes, president and chief executive for Memorial Hermann.

The two systems include 68 hospital campuses, more than 1,100 care delivery sites, nearly 14,000 employed, independent and academic physicians and two health plans; and they currently record nearly 10 million patient encounters annually.

S&P rates Baylor Scott & White AA-minus and Memorial Hermann A-plus. Moody’s Investors Service rates Baylor Scott & White Aa3 and Memorial Hermann A1 with stable outlooks.

They issue tax-exempt debt through conduit issuers including the Harris County Cultural Education Facilities Finance Corp., the Irvine Hospital Authority, the Tarrant County Cultural Educational Facilities Finance Corp., and the North Central Texas Health Facility Development Corp.

Memorial Hermann’s recent capital projects included expansion at Pearland, Sugar Land and Cypress locations in 2016 and 2017. A $700 million expansion of the Texas Medical Center is in progress.

Even if the merger is completed, the combined firms will still face plenty of competition in the Houston area, including CHI St. Luke's and Houston Methodist, which recently completed a new tower on the Texas Medical Center campus.

According to the health care consulting firm Kaufman Hall, 2017 was a record year for medical mergers with 115, including 10 involving hospitals with revenues of $1 billion or more.

The largest regional health system transaction announced was the merger of Advocate Health Care and Aurora Health Care, which would have combined revenue of nearly $11 billion and create the 10th largest not-for-profit hospital system in the country, a report from the consultant said.

“You can’t be too big to compete in today’s developing health care market,” said Kenneth Kaufman, Kaufman Hall's chairman.

Of the 115 mergers and acquisitions, 32% involved for-profit divestitures. The states that were most active in mergers were Pennsylvania with 14, Georgia with nine and Texas with eight.

“Organizational size and scale have mattered for decades, but today, they are proving to be imperatives,” the report said. “Transactions have moved from a heavy financial rationale to a more strategic one, with higher-rated organizations now scaling up at a pace and level that exceeds the steady activity involving smaller and more vulnerable providers.

“Intellectual capital, brand and presence, network infrastructure, risk-bearing capabilities, care continuum, clinical and business intelligence, consumerism, capital resources, and diversified operations represent the most frequently cited benefits of these transformative partnerships,” the report added.

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Healthcare industry Revenue bonds Hospitals and clinics Harris County Health Facilities Development Authority Tarrant County Cultural Education Facilities Finance Corp., TX Texas