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Humana (HUM), the health care company offering insurance products and health and wellness services, announced on Monday that it will acquire Metropolitan Health Networks (MDF). Under the terms of the deal shareholders in Metropolitan will receive $11.25 in cash for each of their shares. Humana, which furthermore announced its third quarter results on Monday saw its shares rise by 0.4%.

The Deal

Humana announced that it has entered into a definitive agreement in which it will acquire Metropolitan in a transaction valued at approximately $850 million, including transaction costs. Metropolitan provides and coordinates Medicare for approximately 87,500 beneficiaries mostly in Florida.

Humana will pay $11.25 in cash for Metropolitan's shares, valuing the equity at roughly $500 million. Including the assumption of debt, the deal value increases to approximately $850 million. Shares in Metropolitan rose 2.8% in Monday's trading session, marking year to date gains of 50%.

Metropolitan's care delivery operations include 35 medical centers and a network of affiliated physicians.

Incoming CEO Bruce Broussard commented on the results, "We believe firmly in Metropolitan's proven integrated-care model and its demonstrated scalability to new markets. With this strategic acquisition, Humana will further expand our capabilities and help to simplify and improve the overall health care experience for our members."

Metropolitan reported $460 million in annual revenues for 2011. The company reported a net profit of $22.7 million for the year.

The deal values the equity of Metropolitan at roughly 1.1 times 2011s annual revenues and 22 times annual earnings.

The transaction is subject to Metropolitan's shareholders, customary closing conditions, and the expiration of the anti-trust waiting period under the Hart-Scott-Rodino act. The deal is expected to close by the end of the first quarter of 2013. The deal is expected to be modestly accretive to full year earnings in 2013.

Valuation

Humana furthermore announced its third quarter results on Monday. Humana reported third quarter earnings of $426 million, or $2.62 per diluted share, down 5 cents on the year. Earnings beat analysts consensus of $2.05 per diluted share. Revenues rose 3.8% to $9.65 billion.

The parent company ended the third quarter with $552 million in cash, equivalents and investment securities. Humana holds $1.6 billion in long term debt, for a net debt position of $1.0 billion. Given the strength of the company, Humana has sufficient strength to acquire Metropolitan.

For the first nine months of 2012, Humana generated revenues of $29.6 billion. The company net earned $1.03 billion, or $6.27 per diluted share. Full year diluted earnings per share are expected to come in between $7.25-$7.35 per share. The outlook exceeds consensus estimates of $7.11 per share.

Humana is currently valued at $12.2 billion. This values the firm at roughly 0.3 times annual revenues and 10 times annual earnings.

Humana currently pays a quarterly dividend of $0.26 per share, for an annual dividend yield of 1.4%.

Investment Thesis

Year to date, shares of Humana have fallen some 14%. Shares rose from $87 in January to highs of $95 later that month. Shares steadily fell back to lows of $61 in July. Shares recovered, currently exchanging hands at $75.

Over the past five years, shares of Humana fell from $85 in 2008 to lows of $20 in the beginning of 2009. Shares rose back and reached all time highs earlier this year. Between 2008 and 2012, revenues rose from $28.5 billion to an expected $39-$39.5 billion in 2012. Net income doubled from $647 million to a guided $1.2 billion this year.

The deal of Metropolitan is rather small for a firm like Humana. The deal adds roughly 1.2% in annual revenues. The revenue multiple of 1.1 times is rather rich compares to Humana's own valuation of 0.3 times annual revenues. Metropolitan is more profitable, reporting net income margins of 5.0% compared to 3.0% for Humana. The growth potential is based on the future prospects of the Medicare legislation. Management did not specify revenue or cost synergies, but expect to see significant savings in the IT department.

Humana furthermore announced the acquisition of Certify Data Systems, a company focused on health information technology. The deals make strategic sense as Humana diversifies from a "claim paying" health insurer, into a diversified health care company.

The deal is rather small for Humana but it does make strategic sense. Third quarter results furthermore beat analysts consensus and the valuation is fair. While there might be upside from today's levels, do not expect the valuation discount with other health care providers to close. The increased reliance on the government insurance business creates significant medium term political risks.

Source: Humana - Metropolitan Increases Its Reliance On Government Insurance Businesses