How healthy is WellPoint's Amerigroup deal?
The move is a big bet that states will allow for Medicaid expansion.
When news broke on Monday that WellPoint (WLP) would buy the Medicaid-focused insurer Amerigroup (AGP) for $4.9 billion, the deal sent shock waves through the health care industry -- and AGP shares rose 38%.
By acquiring AGP at the premium price of $92 a share, WellPoint (whose shares rose about 3% on the news) is going all-in on the government-sponsored managed care market.
The deal will expand WLP's Medicaid business to a total of 19 states, whose citizens account for nearly 60% of the current Medicaid population. WLP will finance the transaction through a combination of about $700 million in cash on hand and the issuance of new commercial paper and debt.
Apart from what the merger means to the two companies and their shareholders, the first deal since the Supreme Court upheld President Obama's signature health reform law as Constitutional signals the start of a paradigm shift in the industry. And that shift will spark radical changes in the way all of its stakeholders do business -- and how most U.S. citizens receive health services.
That applies particularly to the nation's working poor who can't afford private health insurance, but make too much money or are too old for most Medicaid programs, yet too young to qualify for Medicare. The Affordable Care Act expands Medicaid to cover uninsured persons of all ages with incomes up to 133% of the federal poverty line.
Discussing the deal on a conference call with reporters and analysts on Tuesday, WellPoint CEO Angela Braly predicted the total Medicaid market would expand by up to 15 million individuals in 2014, when the ACA's coverage provisions kick in. "Over half of this expansion will occur in our 19 combined Medicaid states," she said. "We project that 29% of the population in our 14 Blue markets will be eligible for Medicaid in 2014."
Perhaps the most significant opportunity for WellPoint and Amerigroup lies in the so-called "dual-eligible" population: individuals who by income are eligible for Medicaid and who by age or disability are eligible also for Medicare.
"The dual-eligible expansion opportunity is tremendous and was the driving force for this transaction," Braly said. "Recent estimates have indicated that approximately 9 million people who are dually eligible for both Medicare and Medicaid today account for approximately $300 billion of annual health care spending."
Here are three takeaways from the WellPoint-Amerigroup merger agreement:
It's Just the Beginning of the Sector's Consolidation: Now that the Supreme Court has blessed most of the ACA, expect more deals among health care giants aimed at hitting promising new markets and achieving competitive advantage and economies of scale.
But States Can Still Opt Out of Medicaid Expansion: Although the high court upheld the most important parts of the ACA -- including its controversial "individual mandate" -- the provision the justices quashed was the one that would have benefited Medicaid insurers like Amerigroup most. The court ruled that the federal government couldn't force states to expand their Medicaid programs by threatening them with the loss of all federal Medicaid funds. The governors of Florida, Texas, South Carolina, Louisiana and Mississippi already have said they won't expand their programs, and other states could follow suit. That could dilute the merger's value proposition in the short run.
Acquirers Must Balance Price With Opportunity: Just because a merger can fast-track a health care company into a potentially lucrative business doesn't mean price is no longer a factor. Conversely, many big Medicaid players are starting to look expensive. AGP and Centene (CNC) are trading around 22 times earnings right now. Molina Healthcare (MOH) has a forward price-to-earnings ratio of 29. That compares to other companies with low valuations like Humana (HUM), with a forward price-to-earnings ratio of about 9, while Coventry Healthcare (CVH) and HealthNet (HNT) have forward price-to-earnings ratios around 11.
I like WLP's strategy of buying a company that is very well positioned to keep winning state Medicaid contracts. I also believe the merger will put the combined company on solid footing to compete for that $300 billion in Medicaid/Medicare dual-eligible business.
However, I don't like the premium price of $92 a share on this deal -- particularly given the risks that more states ultimately will resist the Medicaid expansion despite its substantial near-term benefits.
Although much smaller, a stock I like in the sector is AGP rival WellCare Health Plans (WCG), a provider of managed care exclusively to government-sponsored health plans, focusing on Medicaid and Medicare. At around $63 per share, WCG is up nearly 20% since the WellPoint-Amerigroup deal was announced, but still has a forward price-to-earnings ratio of less than 12 and a nice price/earnings-to-growth ratio of less than 0.9.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.
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