Bloomberg News

WellCare Joining Universal as Bait With Aging Boomers: Real M&A

October 26, 2011

Oct. 26 (Bloomberg) -- Aetna Inc.’s dearth of Medicare customers as baby boomers reach retirement age is transforming WellCare Health Plans Inc. and Universal American Corp. into takeover targets.

Cigna Corp.’s $3.8 billion deal to buy Healthspring Inc. this week has left Aetna with the fewest Medicare customers among the five largest U.S. health insurers, according to data compiled by Bloomberg. Buying Coventry Health Care Inc., with 1.37 million Medicare customers, or WellCare, with 1.07 million, would give Aetna’s 837,000-member program the biggest boost, the data show. Universal American, which primarily manages Medicare plans, is the cheapest U.S. health insurer relative to earnings.

As many as 7 million Americans will become eligible for Medicare in the next five years as the first wave of baby boomers turns 65, and an even higher percentage of the program’s beneficiaries will enroll for managed-care services that companies such as Aetna provide, according to Wedbush Securities Inc. With growth in Medicare outpacing commercial insurance as unemployment hovers above 9 percent, Coventry, WellCare and Universal American are all large enough to “move the needle” for Hartford, Connecticut-based Aetna to gain scale in the Medicare business, said BMO Capital Markets.

“There is basically not that much growth available,” Sachin Shah, a Jersey City, New Jersey-based merger arbitrage strategist for Tullett Prebon Plc, said in a phone interview. “They have an opportunity to gain scale. It’s a no-brainer.”

Today’s Trading

Cynthia B. Michener, a spokeswoman for Aetna, said in an e- mail the company doesn’t comment on rumors or speculation.

Aetna advanced 1.7 percent to $38.97 at 9:55 a.m. in New York. WellCare rose 1.5 percent to $47.54, while Coventry gained 0.9 percent to $32.28. Universal American increased 2.8 percent to $11.31.

Cigna announced an agreement on Oct. 24 to buy Franklin, Tennessee-based Healthspring for $55 a share in cash to triple the Medicare customers it serves to 1.75 million, according to data compiled by Bloomberg.

Aetna, along with UnitedHealth, was among the other insurers to be approached by Healthspring to see if they would be interested in making a rival bid to Cigna, said two people familiar with the matter. Aetna made an offer that was topped by Cigna, the people said. Healthspring contacted a few other firms after initial talks with Cigna indicated the two sides could come to a deal, said one of the people, who couldn’t be named because the discussions were private.

Medicare Advantage

Tyler Mason, a UnitedHealth spokesman, said in an e-mail he couldn’t comment on rumors or speculation. Tony Hughes, a spokesman for Healthspring, declined to comment.

Aetna ranked fourth in Medicare Advantage and Medicare Part D customers in the second quarter among the five U.S. health insurers with the largest market values, data compiled by Bloomberg show. When Cigna’s deal for Healthspring closes, the combined company will push Aetna to fifth place.

Medicare Advantage is a managed care plan offered by the commercial insurers that covers medical costs, including physician fees and hospital charges. Medicare Part D is insurance coverage for prescription drugs.

UnitedHealth Group Inc. serves the most Medicare customers at more than 7 million as of the third quarter. Humana Inc. ranks second with 4.3 million, followed by WellPoint Inc. at 2.6 million members as of the second quarter, according to the most recent data available from the companies.

‘Growth Vehicle’

“It is important for Aetna to find a growth vehicle and Medicare can definitely be that,” Dave Shove, an analyst at BMO Capital Markets in New York, said in a phone interview. “If you’re going to sell in the Medicare space, just like any retail product, you need to be able to commit the resources to sell the product, and that’s when scale comes to play.”

Investors are currently willing to pay 7.9 times Aetna’s estimated earnings in 2012 to own the company’s shares, the second-lowest price-to-earnings ratio in the managed-care industry, according to data compiled by Bloomberg. The only insurer cheaper is Healthways Inc., the manager of diabetes and health disease services that fell 44 percent yesterday after saying it expects to lose a contract with Cigna because of the Healthspring deal. Franklin, Tennessee-based Healthways trades at 7.3 times estimated 2012 earnings, the data show.

The government pays about half of the total medical bill for the U.S. through programs such as Medicare and Medicaid. Once the states create the insurance exchanges mandated by President Barack Obama’s 2010 health overhaul, that percentage will rise, making it hard to be in health care and not do business with the federal government.

‘Huge Growth Potential’

Medicare, the U.S. health plan for the elderly and disabled, may boost revenue for insurers that manage such plans by $10 billion in the next five years as more Americans become eligible, Sarah James, an analyst at Wedbush in Los Angeles, wrote in an Oct. 24 report. The first baby boomers -- people born between 1946 and 1964 -- are turning 65 this year.

About 25 percent of seniors are currently covered by commercial managed-care plans, rather than directly by Medicare, creating “huge growth potential,” according to Dave Windley, an analyst at Jefferies & Co. in Nashville, Tennessee.

Wedbush’s James expects as many as half of Medicare’s enrollees to sign up for managed care within five years as the ranks swell with a generation more familiar with preferred provider networks and health maintenance organizations.

“Aetna needs more Medicare exposure to be a player longer term,” said Tom Carroll, an analyst at Stifel Nicolaus & Co. in Baltimore. “Over time you’re going to see a lot more consolidation aimed at building scale. But the list of potential targets, particularly bigger ones, is dwindling.”

Medicare, Medicaid

WellCare of Tampa, Florida, has 1.07 million Medicare customers between Medicare Advantage and Medicare Part D, data compiled by Bloomberg show. The insurer would give a buyer like Aetna a presence in more states and an expanded portfolio of both Medicare and Medicaid, the joint federal-state program for low income Americans, said Stifel Nicolaus’ Carroll.

“WellCare would be an extremely strategic acquisition to gain access to a bigger piece of government business,” Carroll said. “It should also be a willing seller.”

Amy Knapp, a spokeswoman for WellCare, said it’s “not appropriate” for the company to comment on rumors or speculation.

‘Serving Our Members’

“We are focused on serving our members, growing our business and helping our government customers effectively manage their rising health care costs,” Knapp said in an e-mailed statement.

WellCare and Universal American each have a 30 to 50 percent chance of being acquired in the next 12 months, Robert Boroujerdi, New York-based Goldman Sachs Group Inc.’s co- director of Americas equity research, wrote in a report last week.

Universal American, which only has about 168,000 Medicare Advantage members after selling its Medicare Part D unit to CVS Caremark Corp. this year, is the most attractive near-term acquisition, Wedbush’s James said. Unlike WellCare and Coventry, Universal American offers a virtually pure Medicare takeover.

Laurie Schaen, a spokeswoman for Rye Brook, New York-based Universal American, didn’t respond to calls requesting comment.

Biggest Increase

Coventry, based in Bethesda, Maryland, would provide the biggest increase to Aetna’s Medicare business. The company had 1.37 million Medicare customers at the end of the second quarter, which would boost Aetna to 2.2 million members, enough to surpass the combined Cigna and Healthspring, data compiled by Bloomberg show.

Matt Eyles, a spokesman for Coventry, which also sells plans to smaller businesses and Medicaid, said he couldn’t comment on speculation.

“The next couple of years will be very disruptive as people evaluate which relationships are really necessary,” Eyles said in an interview. “If health-care reform remains in place, the government will no doubt play an increasingly bigger role.”

Universal American currently trades at 6.5 times earnings, the cheapest among 15 U.S. medical-HMO companies, according to data compiled by Bloomberg. Coventry is valued at 8.4 times profit, the third-lowest level, the data show.

Aetna has the highest net debt level of any company in the industry at $1.5 billion, data compiled by Bloomberg show. Larger rivals UnitedHealth and WellPoint both have cash holdings that exceed their borrowings to potentially utilize for acquisitions. WellPoint’s net cash of $10.7 billion ranks as the highest among U.S. managed-care providers, the data show.

Highest Premium

The premium that Cigna offered this week for Healthspring suggests that further deals in the industry may not come cheap, according to Dan Mendelson, president and chief executive officer of consulting firm Avalere Health LLC in Washington. Cigna agreed to pay 45 percent more than Healthspring’s 20-day trading average of $37.89. That’s the most expensive premium since Cigna’s offer of a 50 percent premium for Healthsource Inc. in 1997, data compiled by Bloomberg show.

Applying the premium paid for Healthspring, Universal American would fetch about $1.2 billion in a takeover, excluding net debt. Coventry would be valued at $6.9 billion and WellCare at $2.9 billion, data compiled by Bloomberg show.

Deals like Cigna buying Healthspring “make a lot of sense, but Cigna paid dearly to balance out its portfolio,” Mendelson said. High takeover premiums are “one reason why there hasn’t been more activity in the Medicare and Medicaid space, despite the projected growth,” he said.

Including net debt, Aetna’s biggest takeover was the $600 million purchase of Prodigy Health Group Inc. agreed to in April, data compiled by Bloomberg show.

“Aetna could step in and do a sizable multibillion-dollar deal,” Wedbush’s James said in a phone interview. “They are open to growing in Medicare. The options of material size are dwindling.”

--With assistance from Tara Lachapelle in New York. Editors: Sarah Rabil, Andrew Pollack.

To contact the reporters on this story: Pat Wechsler in New York at pwechsler@bloomberg.net; Devin Banerjee in New York at dbanerjee2@bloomberg.net; Jeffrey McCracken in New York at jmccracken3@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Reg Gale at rgale5@bloomberg.net.


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