WellCare Plummets After FBI Raid

Shares of WellCare Croup (WCG) dropped sharply following an FBI raid of its Tampa headquarters. The Florida based company provides government sponsored health care services to Medicare and Medicaid programs in the United States. After the raid was announced trading of WellCare common stock was halted by the Securities and Exchange Commission. Shortly after the market open the stock resumed trading and gapped down 70 points. Things didn't get much better throughout the day as the stock closed down 72% ending at $42.67.

Despite the huge impact of the FBI's raid on stock price, company officials refused to provide details on the situation. They also requested that the stock resume trading as soon as possible. The lack of insight into the reasons behind the raid instilled fear into the minds of investors. It is likely that the raid was caused by violations of WellCare's contractual obligations with the government. Un-named sources stated that 40 percent of clients were denied coverage that they might have had. Furthermore, WellCare officials wouldn't respond to these clients being denied coverage. Based on these rumors, the stock was punished throughout the course of the day. Having already gapped down over 50% the stock managed to fade near session lows by market close. It should be noted that several "shady" and perhaps illegal activities occurred in the months leading up to the raid.

• A George Soros run private-equity fund completed a sale of its 70% stake of WellCare stock in August for $870 million from an initial investment of $220 million
• Company executives Todd Farha, Neal Moszkowski, Thaddeus Bereday, Paul Behrens, Adam Miller, Christian Machalik, and Alif Hourani dumped massive amounts of shares leading up to the FBI raid. (Source: InsiderCow.com)
• The stock dropped more than 15 points in the two days leading up to the raid.

Although George Soros' private equity fund sale of WellCare stock isn't necessarily alarming, it can't be ignored given the unknown circumstances of the raid. The most troubling part of this situation is the massive sale of stock by company executives. Looking at the public disclosure of insider sales we can see that insiders sold almost $3 million worth of stock just weeks before the raid. In fact, Neal Moszkowski dumped $1 million worth of stock just four days prior to the raid. In the past two years company executives have unloaded over $80 million worth of stock, $47 million in 2007 alone. These kinds of sales usually set off red flags to investors, but with WellCare stock steadily climbing investors seemed to put these sales on the back-burner.

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Source: InsiderCow.com

Now that the stock is down so heavily, questions are being raised as to possible undervaluation. However, valuation prospects will be hard to determine given the lack details provided by company officials. We do know that the company has $1.64 billion in cash and 41.7 million shares outstanding resulting in $39.31 per share in cash. With a closing price of $42.67 the company is presently trading within 10 percent of its book value. At first glance the stock looks like a compelling buy, however this might not be the case. Several reasons lead to that conclusion.

1. The company is likely to face massive monetary penalties for Medicare and Medicaid fraud charges.
2. Class action lawsuits are likely to occur regardless of the outcome of the investigation.
3. Government contracts will likely be lost in the future drying up a large chunk of the company's revenue stream. Connecticut is already searching for alternative companies to take WellCare's place.
4. A small chance of accounting irregularities occurring is possible as well.

If these four scenarios take place investors will be left with a company struggling to survive. Even a few of these scenarios occurring would justify the current stock valuation. On the other hand, the Medicare and Medicaid business likely being targeted, only represents 25% of WellCare's total operations. Assuming that one-fourth of the company's total business is wiped out a $60-$70 valuation would be appropriate. With all the uncertainties surrounding WellCare one thing is clear; executives need to release the details of the probe immediately. The current fear surrounding the company will only continue to put salt on the wounds of shareholders.

Disclosure: none

Comments

[Alan Brochs...:]

While your claim that they have over $1.4 billion of cash is accurate, that cash is spoken for. If you look at the balance sheet, you will see that they have a large amount of short-term liabilities, as is typical for an insurance company (claims payable). Your claim that they trade close to book value is not accurate. Book value isn't cash, it is the difference between Assets and Liabilities (Equity). In the case of WCG, the book value is actually $678mm, but it may be at risk. That value included over $200mm of intangibles, which are very soft assets that could especially be at risk in the present situation.

2007 Oct 29 06:33 AM

[CrossProfit_:]

In addition to the comment above, analysts are now playing judge and jury. In our colleagues' intimate wisdom, they conclude that based on the past, only heavy fines will result without the loss of contracts.

We find this amusing for several reasons.

First, how does anyone conclude anything without knowing the facts?
Second, the nature of the raids suggests criminal activity. In the past when criminal cause was proven, companies seized to exist, especially when the Board of Directors was involved. So, based on history, our colleagues' should conclude the exact opposite.
Third, even were we to get the information regarding the FBI raid, we still have to know what the other States are up to.
Fourth, we still don't know how the class action lawsuits will pan out. Again, if there is criminal activity (emphasis on 'if') then there is less of an impact from the class action suits. If not, then the company will have to shell out to shareholders due to misrepresentation. Either way, the stock has little room for sustainable upside.
Fifth, with regard to the problem being connected to only 25% of revenue, this is not how things work in reality. Once branded, the loss of ability to contract with public entities (should it come to that - we do not know anything more than what has been publicized), the rest of the business goes as well as no one wants to be left holding the bag. It is like a run on a bank.

Our guess (emphasis on guess) is that there is criminal activity implications as the FBI waited to raid until the Board was in session. Think about it!

CrossProfit

2007 Oct 29 10:39 AM

[calven:]

I hope we know more about this whole situation November 5th. I'm assuming WellCare purposely delayed releasing information until that date in order to "lay it all on the table" at the conference call.
The article should read "trading within 10% of cash per share".

Points:
If this is anything like precedents of the "online education companies" not very long ago, shares could have a small rebound.

CrossProfit's point was spot on- the timing of the raid to the board meeting implies that the FBI had some hard evidence on individuals inside the company conducting criminal activity.

While Alan's point on value was well taken, I question why the stock is still trading at $30.00. Given Alan's $678m book value shares should be trading closer to $15.00, why the high premium>?

I would imagine they were overcharging, charging for people that no longer existed (deceased) and denying people coverage...inflating profits.

What do you think of the insider trades over the past year? Any comments on that?

2007 Oct 29 01:38 PM

[Alan Brochs...:]

Outside of planned selling programs, there hasn't been that much selling. Even with the planned programs, I don't view it as being outrageously high, though it is certainly up a lot. Total selling over the past year has been $76mm, while in the prior 12 months it was just $14mm. The CFO has sold about 1/2 his holdings, while the CEO has sold less. They sure did well! You know, the more I look at this, the worse it actually looks...

2007 Oct 29 10:07 PM