Baylor Scott & White, Memorial Hermann call off merger

(Updated Feb. 7)

Dallas-based Baylor Scott & White Health and Houston-based Memorial Hermann Health System nixed their proposed merger five months after they signed a letter of intent, the organizations announced Tuesday.

"As strong, successful organizations, we are capable of achieving our visions for the future without merging at this time," the organizations said in prepared remarks. "We have a tremendous amount of respect for each other and remain committed to strengthening our communities, advancing the health of Texans and transforming the delivery of care. We will continue to seek opportunities for collaboration as two forward-thinking, mission-driven organizations."

The combination of the biggest systems in Texas would have produced a 69-hospital organization with two health plans, about 73,000 employees and nearly $15 billion in annual revenue. Baylor Scott & White opened its 50th hospital in Pflugerville, Texas, in December. It would have been among the largest not-for-profit systems by revenue, according to Modern Healthcare's financial database.

Baylor Scott & White and Memorial Hermann signed a letter of intent to merge in October; the next step would have been a definitive agreement. While executives didn't outline why the deal fell through, there had been some concern regarding the alignment of their academic missions as well as a mismatch of their physician-management models, sources close to the matter said. Their health plans also posed some issues, they said.

"This could actually be a bellwether for the proposition that a knee-jerk toward merging to advance your mission and to shore up perceived weaknesses may not be the best answer," said Joe Lupica, chairman of Newpoint Healthcare Advisors.

Both Memorial Hermann and Baylor Scott & White rely on strong partnerships with employed, independent and academic physicians to help serve their patients and communities, the organizations said in a statement.

The deal represented another iteration of health systems' pursuit of becoming regional powerhouses. Baylor Scott & White and Memorial Hermann executives pledged to expand their academic arms and accelerate the implementation of new technology to drill down on factors that contribute to poor health, among other endeavors.

As regional health systems combine to try to build out certain service lines, save on bundled-supply contracts and increase their reach, economists and policy experts have cautioned about consolidation's tendency to raise prices. This has prompted heightened regulatory scrutiny of hospital mergers.

One study in the relatively unexplored realm of cross-market mergers found that if the merging hospitals were in the same state but 30 to 90 minutes apart, prices increased by about 7% to 10%. There were no significant price changes resulting from mergers between hospitals in different states, according to research conducted by academics from Harvard and Columbia universities. Still, market power may arise from combinations over broad geographic areas due to a common customer base, often large employers looking to cover their employees in different regions, which ultimately reduces competition.

Cross-market mergers "may indeed inhibit competition" and "a merger between hospitals negotiating with the same insurer can yield an increase in the hospitals' negotiated prices even if these hospitals are not substitutes," the researchers said.

"Given the evidence we have seen to date on consolidation, this seems to be step in the right direction for consumers," said Leemore Dafny, a co-author of the study and a professor of business administration at Harvard Business School.

It's unlikely the deal was derailed due to regulatory concerns, said Michael Buchanio, a principal in West Monroe Partners' healthcare practice. Similar to tie ups between Catholic Health Initiatives and Dignity Health as well as Advocate Heatlh Care and Aurora Health Care, the systems are in contiguous markets.

"Federal and state regulators typically get concerned when there is overlap and the hospitals are in-network substitutes," said Buchanio, adding that the two systems would not have publicly announced their intent to merge without confidence that the deal would gain approval from the Texas attorney general or Federal Trade Commission.

It's more likely that something arose related to not finding enough efficiencies to prove financial value, insurmountable culture differences or unforeseen technology integration issues, said Nathan Ray, a senior principal in West Monroe's healthcare practice.

In a presentation for the J.P. Morgan Healthcare Conference last month, Baylor Scott & White said its 2013 merger between Baylor Health Care System and Scott & White Healthcare has resulted in more than $700 million in savings—exceeding its $657 million target. The bulk stemmed from supply chain followed by managed care. Still, according to the latest literature, savings don't always translate to lower prices.

"While it's tough to call off a merger you've already announced publicly, it's not all that uncommon," Ray said. "If they found red flags or if they concluded their investment thesis couldn't be realized, they are doing the right thing by making the call sooner rather than later."

Baylor Scott & White reported operating income of $582.3 million on operating revenue of $9.48 billion in 2018, up from $291.9 million of operating income on $9.09 billion of operating revenue in 2017. Its operating margin improved from 3.2% to 6.1%.

Its operating income dipped in the first quarter of 2019 to $143.8 million on operating revenue of $2.34 billion, down from $153.6 million of operating income on $2.31 billion of operating revenue over the same period last year.

Memorial Hermann's operating income improved to $128.7 million on revenue of $5.26 billion in 2018, from $70.6 million of operating income on $5.06 billion of revenue in 2017. Its operating margin ranged from 1.4% to 6.8% over the past five years.

In the first quarter of 2019, Memorial Hermann reported operating income of $41.8 million on revenue of $1.34 billion, up from a $53.1 million operating loss on $1.24 billion of revenue over the same period last year.

HCA has been encroaching on Memorial Hermann's Houston-area market share, according to Memorial Hermann's year-end report.

Memorial Hermann said in a statement that the decision to scrap the deal was not based on financial concerns.

The merger's collapse is a good sign for area employers, who typically endure higher healthcare costs when hospitals combine, said Chris Skisak, executive director of the Houston Business Coalition on Health, which represents more than 85 local businesses. Still, despite this deal falling through, large hospital system combinations are still being consummated—evidenced most recently by CHI and Dignity combining to form CommonSpirit Health.

Memorial Hermann is a part of an accountable care organization along with Aetna and Houston employers that has not lived up to expectations, Skisak said. The ACO has not been able to significantly dent rising healthcare costs for Houston employers. That is why the coalition set out on its own to try to create a better model, he said.

"The only thing missing from ACO is the accountable part of it," Skisak said. "When you look at the metrics, they are inadequate."

The ACO is a high-performing product that saves money for local employers, Memorial Hermann said in a statement.Aetna mirrored that sentiment and said that the ACO is performing well.

Baylor Scott & White and Memorial Hermann walking away from their merger may be a sign that people are understanding that bigger isn't necessarily better, said Rita Numerof, co-founder and president of a St. Louis-based healthcare consulting firm. Bundling vendor contracts can only save so much, and that scale could be hampered as healthcare becomes less reliant on brick-and-mortar hospitals, she said. Additional scale is not linked to higher revenue, according to a Navigant study.

Limited transparency and accountability has allowed organizations to raise prices to cover up serious flaws in their operating model, Numerof said.

"Those days are over," she said. "We need these organizations, but we need them to be thinking very differently about their business model."