Aetna - Acquisition Of Coventry Creates A Lot Of Value For Both Parties

| About: Aetna, Inc. (AET)

Shares of Coventry Health Care (CVH) rose over 20% in Monday's session after Aetna (AET) announced that it would acquire the company. The deal values the company at $7.3 billion, including the assumption of debt. Shareholders in Aetna are enthusiastic, sending shares 5.6% higher.

The Deal

Aetna announced that it will acquire Coventry Health Care in a transaction valuing the firm at $7.3 billion, including the assumption of debt. Coventry is a diversified managed health care company offering Medicare Advantage, Medicare Part D programs, Medicaid managed care plans and group and individual plans. The acquisition will add a total 5.5 million members to Aetna's current customer base of 37 million members.

The deal increases Aetna's revenue from low-income Medicaid patients from 23% to 30%. The latest deal seems to be driven by Barack Obama's health overhaul plan, which provide clarity for health-care managers.

Aetna's Chairman and CEO Mark Bertolini commented on the acquisition, "Integrating Coventry into Aetna will complement our strategy to expand our core insurance business, increase our presence in the fast-growing Government sector and expand our relationships with providers in local geographies. Coventry has distinct capabilities and a local market focus that will accelerate our efforts to bring simpler, more affordable products to consumer insurance exchanges in 2014 and beyond."

The agreement has been approved by the board of directors of both companies. Shareholders in Coventry receive $27.30 in cash and 0.3885 Aetna shares, for each share they currently own. Based on Friday's closing prices, the deal values Coventry at $42.08 per share. Aetna will finance the acquisition by cash at hand and $2.5 billion in new debt and commercial paper.

Based on Conventry's closing price of $42.04 on Monday, shares trade at a 2.0% discount to the offer.

The transaction will be accretive to Aetna's operating earnings as soon as 2013. While accretion to earnings will be modest in the next year, Aetna expects accretion of $0.45 per share for 2014, and $0.90 per share for 2015. Annual synergies are expected to reach $400 million per annum by 2015.

The transaction is subject to shareholder and regulatory approval. The acquisition is expected to close in mid-2013.


Aetna reported its second quarter results for 2012 on July the 13th. Second quarter revenues rose 6% to $8.8 billion. Net income fell 15% to $458 million, or $1.32 per diluted share. For the first six months of the year, revenues came in at $17.7 billion. The company net earned $969 million, or $2.76 per share.

For the full year of 2012, the company is on track to report annual revenues of $35 billion. It is on track to earn $2 billion, or roughly $5.50 per share. Coventry reported annual revenues of $12.2 billion for its annual 2011. Net income came in at $543 million.

Pro-forma, the company generates annual revenues of $47 billion. The combination is on track to earn $2.5 billion for the full year, or north of $7 per share, excluding financing costs. Based on the annual synergies of $400 million the company could earn $2.8 billion by 2015, or $8.00 per share.

Based on Monday's closing price of $40.18, the market values Aetna at $13.4 billion. This values the combination at 0.3 times annual revenues and 5 times annual earnings.

Currently, Aetna pays a quarterly dividend of $0.17 per share, for an annual dividend yield of 1.7%.

Investment Thesis

Year to date, shares of Aetna fell by some 5% in 2012. Shares peaked at $50 in April, and fell to levels around $35 in the summer months. For the past five years, shares fell 20% despite the fact that the company expanded 2008's annual earnings from $1.4 billion to $2.0 billion in 2011. At same time, Aetna retired about a fifth of its shares outstanding.

Investors are very pleased with the deal, bidding up shares in both companies. Shares of Coventry rose $950 million in value, while Aetna's market value rose by more than $700 million. Coventry's shareholders receive a nice premium, while Aetna's shareholders earn a large degree of the combination's annual synergies of $400 million.

Investors, including myself, are impressed with Aetna's acquisition. The company paid a reasonable premium, leaving Aetna's shareholders to reap most of the benefits. Aetna's shares rose 5.6% in the session given the accretion benefits of the deal. This contradicts to WellPoint's (WLP) acquisition of Amerigroup Corporation (AGP) in July, which was rather expensive.

The deal creates a lot of value, in case the $400 million annual synergies are to be achieved. Aetna is a perfect stock to add for your medium to long term portfolio.

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