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Managed care company Healthspring Inc. (NYSE:HS-OLD) lowered its 2007 earnings outlook last night, noting that the tough medical cost trends pressures across its Medicare Advantage [MA] and commercial products seen in the first quarter have continued into April and May. MA medical cost ratio [MCR] is now seen at 81%-82% for full-year 2007 (vs. prior "less than 80%" guidance) and 82.5%-83.5% for 2Q07. The company said it now expects earnings of $1.20 to $1.35 per share, down from its prior view of $1.55 to $1.65 per share. Analysts had been estimating earnings of $1.59 per share:

- Goldman Sachs notes the press release cites a continuation of adverse costs trends from 1Q07 that were expected to abate but have instead worsened. However, it appears that management's prior characterization of 1Q2007 cost trends as temporary and "flu season"-related was incomplete given the broad-based nature of trend pressures now cited.

With the smallest member block across firm's coverage universe, a greater degree of volatility in MCR and earnings is not surprising. However, the magnitude of adverse trend development is likely to severely test investor confidence in management's ability to forecast and manage trend going forward. Share repurchase signals that management expects a significant pullback in shares, as well as abandonment of its strategy to acquire small MA plans.

- Jefferies think HealthSpring's early 2Q negative pre-announcement will likely cause HS shares to see year lows. News also likely to put pressure on others with meaningful Medicare exposure today. Given the 350 to 450-bp increase y-o-y in Medicare Advantage MLR at Humana (NYSE:HUM) in 1Q07, they would expect HUM shares to be weak on this news.

Both firms will will revisit their earnings estimates following the conference call (9 AM ET.)

- Citigroup lowers their target to $21 from $26 with their 07E-10E EPS by 31c to $1.34 in 07, & by 35c, 40c, 45c in 08E-10E to $1.55, $1.75, $1.90. Maintains Hold rating, as the current bid for HS shares is $17, and they expect the stock to open materially lower.

According to Citi this news adds to a troubling mosaic of data points, notably higher med loss ratios at AET & CI last year; then UNH & WLP in 4Q06-1Q07; and the Citigroup non-profit conference where hospital systems said admissions were better and pricing remained strong. Yet MCOs at firm's conference reiterated that med cost trends are not accelerating. Another clue suggesting this is HS-specific is HS's large drop in days claims payable in 1Q07 that the firm raised a red flag on.

Notablecalls: HS had one of the lowest valuations in the managed care group. Now we know why. I think the stock could be down as much as 4-4 1/2 bucks today, making anything above say the $20-19.50 level a shorting opportunity. I would try bidding around the $17 level for a bounce but I doubt it will get there today.

It sure looks the problems are here to stay for a while (rate increases lagging the costs) and with chatter of additional cost cuts on their way, the picture is turning increasingly bleak. Note that HUM and WellCare Health Plans, Inc. (NYSE:WCG) derive a large portion of their earnings from the Medicare Advantage program. I expect to see selling pressure in both today.

Note that Mike B from Raymond James downgraded HS to Market Perform on May 14 to reflect the potential for higher medical costs. The primary change in his model was an increase in Medicare medical loss ratio assumption by ~50 basis points to reflect the potential for higher costs going forward.

HS 1-yr chart

HS

Source: Healthspring Warning Provides Shorting Opportunity: Big Picture Looks Bleak