By Susan Kelly and Esha Dey
(Reuters) - U.S. hospital operator Tenet Healthcare Corp said on Monday it will buy smaller rival Vanguard Health Systems Inc for $1.73 billion, putting it in a better position to benefit from the millions of Americans about to get insurance under President Barack Obama's healthcare reform.
Investors expect hospital revenue to grow from treating more Americans insured under the reform, and speculation that major hospital chains would increase their acquisitions has fueled stocks in the sector.
As providers prepare for the healthcare overhaul, they are also grappling with a slowdown in the use of medical services. Americans are visiting doctors less frequently and having fewer elective procedures as out-of-pocket costs rise.
"All of the uncertainty around health reform has many healthcare systems concerned about how they are going to navigate this new era. You have to have size and scale to succeed," Tenet Chief Executive Trevor Fetter said in an interview.
Tenet's purchase of Vanguard is expected to close by the end of the year. The U.S. health overhaul takes full effect next January.
The combined company will be the second-largest for-profit U.S. hospital operator, with total revenue of about $15 billion in 2012, behind No. 1 HCA Holdings Inc but surpassing Community Health Systems Inc. Tenet fended off a hostile takeover effort from Community Health in 2011.
Buying Vanguard will give Tenet more clout in negotiations with managed care providers, drug companies and medical device makers, Fetter said, while reducing overhead costs.
Dallas-based Tenet said the expanded chain would have 79 hospitals and 157 outpatient centers, making it No. 1 or No. 2 in 19 key markets, including San Antonio and South Texas.
Fetter told analysts on a conference call earlier on Monday that the deal signaled a new appetite for acquisitions for Tenet, which has acquired only one hospital in the past eight years. "It is a turning point for Tenet," he said.
In addition to healthcare reform - which includes government subsidies to low-income individuals to buy health coverage and an expansion of the Medicaid program for the poor - historically low borrowing costs are helping drive a consolidation wave in the hospital sector.
"The combination of the industry conditions and capital markets creates a very attractive opportunity to be more active in acquisitions, and that's what I plan to be," Fetter told Reuters. "I wanted to signal to the market that, yes, this is a very large transaction, but you should continue to expect us to be active."
Tenet's offer of $21 per Vanguard share, a premium of 70 percent to Vanguard's Friday closing price, represents the highest price for the stock since the company's initial public offering in 2011. Under the deal, Tenet also assumes $2.54 billion of Vanguard debt.
Tenet's stock rose 5.6 percent, while Vanguard soared 68 percent.
Private equity firm Blackstone Group LP is Vanguard's biggest shareholder, with a 38 percent stake. Founder and CEO Charles Martin owns 4.18 percent and will join Tenet's board as a director.
"It's a very smart deal for (Tenet) to be doing at this juncture, and I think gaining the services of both Keith Pitts and Charlie Martin ... is crucial to this," said CRT Capital Group analyst Sheryl Skolnick, who has a "buy" rating on both companies. Pitts is Vanguard's vice chairman.
Analysts said the premium being paid was reasonable, given the potential savings from the deal. Tenet expects the deal to add to earnings in the first year and estimates annual cost savings of $100 million to $200 million.
Tenet operates 49 hospitals and 122 freestanding outpatient centers in California, Texas, Pennsylvania and states in the Southeast. Based in Nashville, Tennessee, Vanguard owns 28 acute care and specialty hospitals in the Midwest, South and Massachusetts.
Tenet said a trend of fewer patient admissions it reported in the first quarter has continued. Admissions are expected to decline by 3.5 percent in the second quarter from a year earlier.
The company sees second-quarter adjusted earnings before interest, taxes, depreciation and amortization closer to the lower end of its previous forecast of $325 million to $375 million.
Gibson Dunn & Crutcher was Tenet's legal counsel in the deal, and Lazard, Bank of America Merrill Lynch, Barclays and Teneo Capital were financial and strategic advisers. Vanguard was advised by J.P. Morgan. Skadden, Arps, Slate, Meagher & Flom was legal counsel.
Tenet said it has secured fully committed financing from Bank of America Merrill Lynch.
(Reporting by Susan Kelly in Chicago and Esha Dey in Bangalore; Additional reporting by Caroline Humer in New York; Editing by Ted Kerr, Michele Gershberg, Jeffrey Benkoe and John Wallace)