Opportunities In The Medicaid-Managed Care Revamp

Includes: ANTM, MOH
by: Russ Winter

Overwhelmed by expenditures, states are seeking to revamp the delivery of their Medicaid programs. Medicaid, on average, accounts for some 20 percent of state budgets, involves $275 billion in spending and serves 69 million eligible enrollees, or one out of every five Americans. Of all babies born in the U.S., 40 percent are covered by Medicaid. Numerous academic studies have estimated that 15 to 17 percent of Medicaid's costs are wasted on administration. States' officials are counting on greater cost predictability and even some savings through a combination of software technology and administrative outsourcing. There's also the prospect of bringing in lower-cost, lower-quality networks in exchange for delivery discounts. It may be inevitable given deteriorating U.S. fiscal conditions.

States are increasingly turning over bigger portions of their programs -- 29 million people so far -- to private health management companies. Between 2011 and 2013, states will award contracts worth $40 to $60 billion. ObamaCare requires each state to open its Medicaid program to all legal residents earning up to an expanded 138 percent of the federal poverty level. The Congressional Budget Office projects 25.6 million more people will be enrolled, mostly consisting of uninsured young adults mandated to enroll. I see this projection as low given that poverty and illness is an entrenched, fast-growing American condition. I think we are at a power inflection point in this theme. An example of how this is unfolding:

July 20 -- FRANKFORT, KY (Kentucky.com) . -- Private companies will manage care for the vast majority of Kentucky's 815,000 recipients of Medicaid, the health insurance program for the poor and disabled that has been a financial nightmare for the state, Gov. Steve Beshear announced Thursday. Starting in October, Medicaid recipients in much of the state will choose among three companies that will compete to manage their care. A massive education program must start immediately, advocates said after the announcement. Beshear described the expansion of managed care as "a major sea change" in the $6 billion-a-year program. The expansion of managed care will save $375 million in Kentucky's General Fund, which pays for most state programs, during the course of new, three-year contracts, Beshear said. [Louisville Gazette]

In the political debate, you will hear rhetoric about how Medicaid is going to be "drastically dismantled," as if benefits and the safety net are going to be removed. Although the political climate may bring about serious austerity that could unwind the 2014 event, I don't see it in the intermediate term.

Actually, the proposals primarily being pushed by 31 Republican governors, and even some Democrats, center around program efficiencies and Federal block grants to the states with outsourced administration. State agencies have already been shrinking and the states are pushing forward on their own. Despite the rhetoric around the Ryan proposal, it did little with Medicare and Medicaid other than try to stop its growth. Medicaid: 2011 $275 billion, 2012 $259 billion, 2013 $262 billion. Medicare: 2011 $563 billion, 2012 $560 billion, 2013 $601 billion.

When the final debt extension agreement went through in August, Medicaid was taken off the table for further cuts in the event that the supercommittee reached an impasse. Separately, Medicaid lowered its baseline payments by 2 percent over 10 years and that, in turn, kicked off a large correction in various medical stocks.

I don't think they'll go beyond this as there is still a large political block of poor, sick and old people in the U.S. that can be cynically utilized as a political and business opportunity. In reality, ObamaCare stuffed an extra three million people into the Medicaid eligibility mix. The program has been greatly expanded by legislation, so what we're seeing is nothing more than a little backing and filling. However, without basic reform on delivery and costs, 2014 (or sooner) will be a real fiscal train wreck.

For those seeking background on the issues, there is an excellent healthcare conference call here. There is always the risk of squeezing vendors, but generally the formulas used are in a sense regulated utilities. In Texas, if a provider exceeds a certain margin, there is a cap on profitability. Then the provider rebates the excess back to the state. States also monitor quality performance and essentially perform audits. Other states, like Kentucky, they put contracts out for price bid -- in effect, dictating price. In the call just referenced, I heard an Amerigroup executive state that the winning bids were too low. This will be important to analyze, as the Texas Model is preferable for providers. Molina Healthcare's conference call said:

"We elected to forego submitting a bid on the Kentucky managed care RFP (contract). In this RFP, over 40 percent of the evaluation criteria was based on a 3-year price bid, effectively locking in reimbursement rates by projecting medical costs for the next 3 years."

States are looking for companies highly experienced with the Medicaid system -- in effect, Government HMOs -- of which there are relatively few. It also takes money and expertise to build a system. There also tends to be pent-up demand in the first year as new enrollees often catch up with health problems. Morally, I consider managed care for this group to be like investing with angels. Of course, we may also assume there could be a good measure of feeding at the trough as icing on the cake for a play like this.

Despite the excellent growth prospects, I'm inclined to apply a fair discount of perhaps 20 percent to the market PE for these plays. I'm tracking Amerigroup (AGP) for an entry, but my first choice at current levels is Molina Healthcare (NYSE:MOH), with 1.65 million subscribers. They have a strong niche in dual benefits (both Medicare and Medicaid). Nine million dual-eligibles consume approximately $300 billion each year for Medicaid and Medicare services combined, mostly in a fragmented fee-for-service system. In California, the state mandated ABD (aged, blind, disabled) patients in various counties to enroll in existing managed care plans starting in the month of June and MOH picked up an increase of approximately 5,000 members in a month. They acquired the Health Information Management business of Unisys to diversify their reach. They run Medicaid Management Information Systems for Idaho and Maine. In August, MOH was one of three contracts awarded by Texas (a real plum), although they will have to invest to have a presence. They picked up Wisconsin in the second quarter. They are participating in expanded service RFPs in Ohio and Washington where they have a presence that can be easily leveraged. Guidance for 2011 is 1.55.

In considering the balance sheet, I have taken away all their goodwill, plant and equipment, other and intangible assets and then subtracted all their liabilities to give a very conservative quick cash asset of $264 million or 5.74 per share [balance sheet]. This should permit expansions or acquisitions in a now depressed sector; or, in turn, they would be a great target for insurance companies seeking entry into this subsector. It would have to be friendly and at a good premium as it's 39 percent insider held. With stock at 16.28 the market cap is $750 million, but when you adjust the quick cash for a conservative enterprise value, the market is putting little value on the enterprise, which generated $250 million in operating cash flow this year. Shorts have piled in to the tune of 9.7 percent of float. MOH represents very deep value in a strong expansion, high barrier of entry, specialty sector.

Disclosure: I am long MOH.