Bloomberg News

Aetna Puts Debt Leverage Above Rivals in Deal: Corporate Finance

August 22, 2012

Aetna Inc CEO Mark Bertolini

While Chief Executive Officer Mark Bertolini has pledged to trim leverage, the purchase’s profitability depends on cuts to management and technology spending that may be difficult to achieve, according to CreditSights Inc. Photographer: Andrew Harrer/Bloomberg

Aetna Inc. (AET:US)’s $5.7 billion purchase of Coventry Health Care Inc. (CVH:US) will take the insurer from about the bottom to the top of leverage among its peers as it seeks to cut $400 million of costs.

Aetna’s push to compete with WellPoint Inc. and Cigna Corp. as the U.S. government increases medical coverage will bring its debt to about 40 percent of capital from about 31 percent, according to Fitch Ratings. That would be the highest among the six firms in the Standard & Poor’s 500 Managed Health Care Sub Industry index.

While Chief Executive Officer Mark Bertolini has pledged to trim leverage, the purchase’s profitability depends on cuts to management and technology spending that may be difficult to achieve, according to CreditSights Inc. The three major credit- ratings firms lowered their outlooks for the Hartford, Connecticut-based insurer after it announced the deal Aug. 20 and said it would take on $2.5 billion of debt to finance it.

“There’s always integration risk,” Mark Rouck, a senior director at Fitch in Chicago, said in a telephone interview. “Aetna, in our minds, still has to show us that it will reduce the financial leverage ratios.”

Fitch said in an Aug. 20 report that it would likely put its A- rating for Aetna’s unsecured debt on “negative outlook” when the deal closes next year. Moody’s Investors Service said it may downgrade Aetna from Baa1, while S&P lowered the outlook for its A- grade to “stable” from “positive.”

‘Lever Up’

Cigna has a 37 percent debt-to-capital ratio as of June 30 after its January purchase of Healthspring Inc., compared with 30 percent for UnitedHealth Group Inc. and 18 percent for Humana Inc., according to data compiled by Bloomberg. WellPoint’s $4.9 billion acquisition of Amerigroup Corp., announced last month, will increase its leverage to 39 percent, Fitch said in a statement at the time.

“We’re certainly seeing companies lever up to do these acquisitions,” Neal Freedman, an analyst for S&P, said in a telephone interview. “We are going to give them time to work down.”

Joseph Zubretsky, Aetna’s chief financial officer, said Aug. 20 on a conference call to discuss the deal that the company would lower the ratio to 35 percent over the next two years, while still paying dividends (AET:US) and repurchasing stock.

Coventry Cash

Coventry has about $850 million in cash, according to Citigroup Inc. The combined company may have earnings before interest, taxes, depreciation and amortization of $3.3 billion in 2014, compared with $2.1 billion for Aetna on its own, according to Citigroup.

Aetna’s $500 million of 4.5 percent notes due May 2042 dropped 3.1 cents on the dollar to 98.4 cents to yield 4.6 percent the day the deal was announced, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities gained back 2.1 cents to 100.5 cents at 10:29 a.m. today, Trace data show.

Aetna will pay $42.08 a share for Bethesda, Maryland-based Coventry, a 20 percent premium over the closing price of $34.94 on Aug. 17. The purchase, expected to close in the middle of next year, will be financed with a combination of cash on hand and about $2.5 billion in new debt and commercial paper. Aetna said in a regulatory filing today that it obtained a $2 billion bridge loan arranged by Goldman Sachs Group Inc. and UBS AG.

‘Needs Scale’

The acquisition extends Aetna’s reach in selling insurance for people on Medicaid, the government-funded program for the poor, as well as private plans sold to individuals and small businesses. Both markets are expected to grow as President Barack Obama’s health-care law expands coverage. The company would also gain more customers on Medicare, the U.S.-backed program for the elderly and disabled.

In all, Coventry will add more than 5 million customers (CVH:US) to the 26.7 million already on medical and prescription drug plans with Aetna, according to the companies’ quarterly reports.

“Many investors have been concerned that Aetna needs scale,” Joshua Raskin, an insurance analyst at Barclays Plc in New York, wrote in a note to clients. With the deal, “Aetna shareholders get a valuable set of assets that help augment the company’s operations in almost every segment.”

Expense Reductions

Zubretsky said on the conference call that Aetna would be able to cut costs by $400 million a year, or 15 percent, by eliminating overlapping layers of management and information technology. The savings “could be difficult to obtain due to the size of the deal,” CreditSights analysts Rob Haines and Eric Axon wrote in a report. The credit-research company, which said Aetna’s debt-to-capital ratio has been stable at about 30 percent since 2009, is maintaining a “market perform” recommendation on the insurer’s bonds.

The cost of the debt to finance the purchase will be about 3 percent a year, Zubretsky said. Interest rates are so low that “virtually every combination that relies mostly on borrowed money adds to earnings,” Carl McDonald, an analyst at Citigroup, wrote in an Aug. 20 report.

Average yields on investment-grade bonds reached 3.15 percent on Aug. 20, close to the record-low 3.03 percent on Aug. 2, according to Bank of America Merrill Lynch index data.

“They’re expecting positive cash flows from this,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. “It’s just a question of can the company return its credit metrics back to where they were pre-acquisition.”

To contact the reporters on this story: Zeke Faux in New York at zfaux@bloomberg.net; Alex Nussbaum in New York anussbaum1@bloomberg.net.

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Reg Gale at rgale5@bloomberg.net


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