Rough ride ahead

When Texas Health Resources announced in December the purchase of Medical Edge Health Group, officials said they weren't sure how the expanded health system would fully fit its more than 400 new employees.

Eight months later, that integration remains THR's “primary challenge facing management,” said Moody's Investors Service. The agency revised the system's credit outlook from stable to negative.

But Moody's forecasts a rough financial road for the faith-based Arlington, Texas-based system and its more than 3,500 staffed beds.

Part of the concern comes from THR's $200 million of debt outside the obligating group, which Moody's said includes $20 million of guaranteed debt from the Medical Edge deal.

First-quarter losses in fiscal 2010 throughout THR's physician chain have left a negative impact on the budget, and poor performances at some of THR's larger hospitals also weighed down the system, Moody's said. There's also a 1.4% improvement in operational cash flow in fiscal 2010 to 12.6%.

There's hope, Moody's said, as THR's operating margins spiked by 1.3% to 5.9% in fiscal 2010. That shows management's ability to improve performance while coping with the struggles of fiscal 2008, Moody's said.

THR announced the $176.4 million deal to acquire Medical Edge in December, and the transaction included $34.7 million in liabilities, according to the health system's financials. The deal also came with the acquisition of PhyServe Physician Services, the physician office management company that supported Medical Edge, the largest-independent physician practice in the Dallas-Fort Worth Metroplex. THR in January later sold PhyServe to Texas-based Med Synergies.

Douglas Hawthorne, Texas Health's CEO, described the deal as a strategic and long-term investment that added more than 250 physicians to its Texas Health Physician Group, which previously employed 236 doctors. Such growth “at one swoop” would otherwise have required multiple deals over multiple years, he said. The rapid expansion better positions THR for changes to reimbursement that promote preventive and primary care, such as accountable care, he added.

THR moved swiftly to acquire the practice after talk last summer that Medical Edge physicians would consider a deal, Hawthorne said, as Texas Health rushed to beat competing offers that could have emerged. Half of Medical Edge's doctors had no professional relationship with THR. The system now expects to see new revenue as those physicians refer patients to specialists inside the system, he said.

Dr. Cliff Deveny, senior vice president of physician practice management for Englewood, Colo.-based Catholic Health Initiatives, said it takes two to five years for a health system to fully integrate a recently acquired physician practice. Factors that slow the transition include allowing a doctors group to remain on an old computer system, rather than moving the group to the health system's technology setup.

Many health systems lack what Deveny pegged as the discipline to adhere to a business plan. They fail to take into account the costs of integration, which include ensuring IT and code compliance. But the biggest challenge these deals face is how the new practice fits into the health system's plans, Deveny said. The looming question is will the practice continue to operate as it has with few changes, or will the health system fully absorb it?

“There really has to be an understanding of each other's culture,” he said.

Now midway through a financial planning update, THR is searching for ways to curb its expenses to offset the physician acquisition and maintain its credit rating, said Ronald Long, THR's executive vice president of resource development and deployment and chief financial officer. That means coping with increased operational expenses, including a full year of rental expenses from Medical Edge, which Moody's pointed out. The report did not break out those expenses.