A 'Supreme' Lift For Wellpoint

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The U.S. Supreme Court ruled in June that the Patient Protection and Affordable Care Act (PPACA) passes constitutional muster, upholding the individual mandate and striking down only one provision of the law.

I largely expected this outcome. I won't comment on the wisdom of the law, but in the wake of the ruling the health care sector has been the top performer.

Health care providers and insurers anticipate about 35 million new customers and billions of dollars in additional spending, when the law's requirement for every American to carry insurance or pay a penalty comes into effect by 2014.

Despite the top court's ruling, PPACA isn't completely out of the woods. Republicans have made the law's repeal a major plank in their 2012 campaign platform. However, with Republicans and Democrats in a statistical dead heat in most of the key November races-including the one for the White House-it looks likely that it will take at least another four years for any repeal efforts to gain traction, by which point the law will be entrenched.

Now could be a good time for investors to look at WellPoint (WLP).

Covering approximately 34 million patients in 14 states, WellPoint is one of the largest managed care companies in the nation. It is also one of the largest in terms of the number of medical practitioners offering their services through WellPoint's insurance networks.

The size of its network has allowed WellPoint to develop substantial pricing power in its markets. Moreover, being the exclusive licensee of the trusted Blue Cross Blue Shield name has made the company extremely attractive to its target market of small businesses.

Despite its clear advantages, WellPoint has been walloped in the market after it announced its intention to buy Amerigroup (AGP) for $4.5 billion. Ordinarily, such an announcement wouldn't be a major market-moving event, particularly since WellPoint expects the deal to add at least $1 to earnings per share within the next two years.

However, the perceived problem is that Amerigroup primarily serves 2 million Medicaid patients in 11 states.

Although the Supreme Court upheld the majority of PPACA, it struck down the provision that would have allowed the federal government to withhold all federal Medicaid funding from states that did not participate in the expansion of the program called for under the law.

Republican governors already have said that they will refuse to participate in the Medicaid expansion, spooking investors who worry that WellPoint is making an acquisition in anticipation of a market development that may not come to pass.

It is not my job to espouse any political position. However, sheer pragmatism dictates that the Medicaid expansion is likely to occur because it will benefit hundreds of thousands of people in each state, primarily children, the poor and the elderly.

What's more, the federal government is picking up the entire tab for the revamped Medicaid program through 2016, with states only responsible for about 10 percent of the cost thereafter. Refusing to accept this largesse could make for tricky campaigns in the next election cycle, even in the most conservative states. Advocates for the poor and many hospital associations already are pushing back on gubernatorial efforts to opt out of the law's Medicaid plan.

While a few states may ultimately decide not to participate, I expect most to acquiesce. Within Amerigroup's coverage area, Texas and Florida are the only states in danger of not joining the Medicaid expansion.

Consequently, WellPoint's acquisition of Amerigroup should not only net it about 2 million new customers, but also allow it to claim a bigger slice of the estimated 18 million Americans who would be covered under the broader Medicaid program.

Even if the law's Medicaid expansion were to hit some bumps in the road, the acquisition of Amerigroup is a savvy decision, as a growing number of states privatize their Medicaid plans to cut costs and improve coverage. By acquiring Amerigroup, WellPoint will get the systems it needs to better compete for privatized Medicaid business.

In addition to these tailwinds, WellPoint is attractively valued, trading almost on par with its book value and at a small discount to its expected earnings growth. WellPoint also pays a small quarterly dividend with a current yield of 1.8 percent. Check out this article for more stock picks that could benefit from the Patient Protection and Affordable Care Act.

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

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