How To Profit From The Coming Healthcare Consolidation

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Includes: AET, ANTM, CI, HUM, UNH
by: Henry Stokman

Summary

Currently there is a 30% upside potential in both Humana and Cigna shares pending a DOJ approval of their respective mergers.

Given the amount time, money, and energy that will ultimately go into the post merger consolidation United Health looks to be an attractive purchase.

There is a case to be made for the DOJ approving these mergers, but Cigna/Humana might have a stronger case in the end.

Last summer a string of healthcare deal making was creating headlines as several of the larger healthcare insurers put out merger bids for competitors in a wave of sector consolidation. As the dust settled the existing 'big-five' healthcare insurers Aetna (NYSE:AET), United Health Group (NYSE:UNH), Anthem (NYSE:ANTM), Cigna (NYSE:CI), and Humana (NYSE:HUM) would ideally becoming three. Aetna put forth an offer to buy Humana for $37 billion. While Anthem agreed to buy Cigna for $48 billion.

Both of these deals came within three weeks of each and put forth a strong statement to the broader market that as more and more healthcare providers consolidate in the wake of the Affordable Care Act the need for increased efficiencies and economies of scale with the insurers was required. From both a cost efficiency and scale standpoint the need for consolidation was apparent and is the main argument of the insurers in moving forward with the deals. Of course both of these deals will ultimately require Department of Justice approval which is expected later this year, which could prove to be challenging.

Both deals involve a combination of both cash and stock, below I have highlighted the details and current prices compared to potential purchase price below.

· Anthem/Cigna Deal - Each Cigna shareholder will receive $103.40 in cash and 0.5152 in Anthem stock

· Aetna/Humana Deal - Each Humana shareholder will receive $125 in cash and 0.8375 in Aetna stock

 

Current Stock Price

Assumed Purchase Price

Total Upside Potential

Cigna

$128.20

$165.15

28.82%

Humana

$159.60

$206.40

29.30%

Click to enlarge

Now it is difficult to know whether or not the DOJ will ultimately approve either of these deals. What we can do is examine the business case for the deals to get approval and determine the likelihood of such approval. Back in October Aetna shareholders approved the pending deal with Humana, as did shareholders of Anthem for their pending deal with Cigna. Additionally, both executive teams claim that the deals would not only create increased efficiencies in both businesses, but they also claim that consumers would benefit from the combination of the companies, ultimately allowing consumers to have more options to choose from at more competitive prices.

The argument that less competition is going to create greater value and more price competitiveness for the consumer I think is going to be a tough sell to the DOJ. That being said, the fact that the current environment is getting more difficult to work in, especially with the shareholder expectation of maintaining a profitable margin. As the financial impact of the ACA continue to grow the need for synergies and greater efficiencies in costs and time are going to be needed. Between the two pending deals I feel the Aetna/Humana deal has the highest likelihood of occurring. For starters I think the combination of the two businesses makes sense and an argument could be made that it would be good for consumers.

Humana is an industry leader when it comes to Medicare Advantage plans, an area where Aetna is not as dominate in. While Aetna currently has a strong commercial business that is well run and the combination of the two would create a platform for more offerings, potential for higher quality, and a bigger footprint geographically. With an estimated 10,000 new Medicare enrollees occurring every day and an estimated one in three choosing to enroll in an Medicare Advantage plan the market demand is there and growing for the services that the combined Humana/Aetna would have to offer. In a statement made to shareholders back in October about the pending merger, CEO of Aetna Bertolini said 'In Humana, we have found the ideal partner to complement and accelerate our efforts to help reshape the health care system to be more consumer-centric in order to give our members as many healthy days as possible'.

The other reason I like the chances of the Aetna/Humana deal over Anthem/Cigna is the fact that the combination of Aetna and Humana would not dethrone United Health as the largest insurer in the country. That may sound strange, but from the standpoint of the DOJ there job is to prevent monopolies from forming and any deal that might make something bigger than what already exists might raise some eyebrows. Additionally, the Aetna/Humana deal was the first deal like this to go through, so it also would not surprise if the DOJ approved the first one but not the second one just so they could say that they were comfortable with a consolidation from 5 big players to 4, but not 5 to 3.

Regardless everything at this point in the game is all speculation and it is almost impossible to know what the DOJ will ultimately do, which is why both the stocks of Humana and Cigna have not traded even close to their potential purchase price since the announcements. Getting back to the purpose of this article on how to play the coming consolidation, I think the answer is simple, buy United Health Group.

My reasons for this are simple. United Health is currently the larger player in the market and if I am right most likely will continue to be. Even if I am wrong and both deals go through that too would be great for United Health. For the simple reasons associated with the amount of time, energy, and money that it is going take to get each company to successfully merge into the other. This will create a great amount opportunity for United Health to potential steal market share or further develop new products, ramp up its current go to market strategy, and possibly even acquire any smaller businesses that the two larger companies may have to sell off in order to help get DOJ approval.

Bottom line is that although it is difficult to say what the DOJ will ultimately do with these two deals. I think approval of one or both would be a major plus for United Health. As United Health will be business as usual focusing on its market share and growth, they will enter into a non-competitive world where their competitors will simply be too busy trying to figure out how to make two massive companies now operate as one.

Disclosure: I am/we are long UNH, HUM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.