Health Insurers Continue To Face Hurdles

| About: Humana Inc. (HUM)


Centene has doubled revenue post-acquisition.

The DOJ has attempted to block the big merger deals.

The deal closing date for Humana-Aetna is questionable.

Centene (NYSE:CNC) released earnings last week, proving the growth in the managed care industry. But does growth necessarily translate into profits for health insurers? Not if you are being challenged by the Department of Justice.

Centene Earnings

Centene's Managed care membership increased 148% to 11.4 million members and total grew 98% to $10.9 billion, compared to year over year. The health benefits ratio, a critical metric for all health insurers, dropped to 86% from 89% because of the higher number of commercial and Medicare patients who tend to have lower expenses. The HealthNet integration is ahead of schedule and believed to deliver $50 million in synergies for the rest of 2016.

Merger update

The media wrongly believed that Centene was qualified to acquire Aetna's (NYSE:AET) assets. Centene is still working on its HealthNet integration, which will stall it from making any acquisitions in the near term. Losses from Obamacare are rising, even for Centene-HealthNet. Centene put up a $300 million reserve fund to hedge against losses from HealthNet's membership on the California and Arizona exchanges. They have already planned to consolidate to a single county in Arizona for 2017. The healthcare exchanges have turned out to be unprofitable for many insurers and we have seen UnitedHealth (NYSE:UNH) and Humana (NYSE:HUM) declare exits from the national exchanges.

Centene has squashed any possibility that it may acquire Aetna's Medicare Advantage assets in order for HUM-AET to proceed. The CEO was quoted saying that the company will not enter a bidding war for such assets and anything else should be considered a rumor.

The U.S. Department of Justice has sued to block Aetna's purchase of Humana and challenged the Anthem (NYSE:ANTM)-Cigna (NYSE:CI) deal as well. In my mind, both of these deals now have tremendous hurdles to overcome. In order for both deals to go through, all companies will be required to divest non-core assets in order to reduce monopolization in certain markets. Divestitures can be difficult to execute now since the market is controlled by such few players. Last week, Cigna's CEO declared the company would have $5 billion in 'deployable cash' if the Anthem deal does not go through. A statement like this suggests the chief executive himself is not 100% certain that the deal will go through.

This is not the first time physician groups and regulators have already voiced their concerns in many markets because of the monopolistic concerns from new conglomerates. Insurers can have the ability to increase prices in certain regions, as is the nature of monopolies. All of the health insurers have announced they can achieve greater efficiencies post-acquisition. This may be true but given the history of third party administers, synergies will not be realized as quickly as management predicts.

Even Molina Healthcare (NYSE:MOH) executives recently spoke of the mounting challenges with acquisition integration at their Analyst/Investor day meeting in New York. The only company left I believe that can acquire Aetna's assets may be WellCare Health Plans (NYSE:WCG). Given WCG's cash rich balance sheet and experience in both Medicaid and Medicare, they may be a qualified buyer. This is speculative and definitely a topic for another article.

On the other side, S&P Global Ratings stated a deal breakup of Aetna-Humana would be a positive for both companies. The size of the deal put both companies under credit watch, possibly lowering their credit ratings in the future. Lower credit ratings would increase the cost of borrowing for both companies, making it more difficult to achieve deal synergies.

Investment update

Humana shares could collapse if the deal is blocked by the DOJ. The arbitrage trade could unwind and Humana shares can drop more than 10% from such an announcement. Unfortunately, this won't be the first time for Humana. In 1998, Humana and United Healthcare had to break up their original $5.5 billion merger deal due to the poor performance from United's stock. This breakup was a mutual decision and is a risk investors need to be aware of today. Market conditions are one variable we cannot control even if the deal looks absolutely certain.

We have closed our HUM position because the probability of a deal closing has dropped significantly over the past few weeks. Investors trading either M&A deals need to account for the probability that these deals may not close by year-end. If these deals do take longer than expected, it will substantially reduce the internal rate of return (IRR). Retail investors need to keep this in mind if they want to stay ahead of the market.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: At the time of this commentary Vijar Kohli, his family and/or clients of Golden Door Asset Management held no positions in the stocks mentioned - although positions can change at any time. Vijar Kohli is the Portfolio Manager of Golden Door Asset Management, LLC, a registered investment advisor specializing in individual and high net worth individual private wealth management. For more information on investing with Golden Door Asset Management, LLC please visit our website, Golden Door Asset Management, LLC is a New Jersey LLC, with its principal office located in Manalapan, NJ. Vijar Kohli is also the publisher of CareStocks, a newsletter focusing in on healthcare services, medical equipment, technology and real estate stocks. More information to the newsletter can be found at © 2015 Golden Door Asset Management, LLC. All rights reserved.