Why Centene Is A Good Opportunity

| About: Centene Corporation (CNC)
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This year, the Patient Protection and the Affordable Care Act, or PPACA, jointly known as Obamacare, has brought positive changes that will benefit both the U.S. citizens as well as the healthcare providers. It plans to qualify millions of low-income citizens for its Medicaid program, where the federal government will fully pay the coverage, which at present is half-paid by the states and government jointly. Approximately 16 million U.S. citizens are expected to be insured through Medicaid by the year 2016. In 2012, 18 states expanded their Medicaid programs and more than 30 states are expected to join by 2013. Henceforth, this will bring a huge opportunity for healthcare providers in the coming years.

The large players in this market are WellPoint (WLP), UnitedHealth Group (UNH), Centene (CNC), and Molina (MOH). WellPoint and UnitedHealth each account for 8% market share, while the other two have a market share in the range of 3% to 4%.

These four companies form nearly one-fourth of the U.S. Medicaid-managed care industry. Centene is expected to gain growth potential, as there are only a handful of healthcare providers in each state in respect to the increasing number of Medicaid enrolees.

Business model

Centene, being one of the largest Medicaid-managed care plan companies, operates in more than 19 states in the U.S. Its business is broadly divided into two segments called Medicaid managed-care and specialty services.

The Medicaid managed-care segment alone contributes nearly 63% of the company's total revenue. It is estimated to boost revenue by about 13% from $1.84 billion in 2012 to $2.08 billion in 2013.

The specialty service segment consists of eight specialty companies focusing on providing solutions to problems faced by patients, healthcare providers, state government, and pharma companies. These services include child health plans, foster care, Medicare, hybrid programs, long-term care, telehealth services, and many more. This segment constitutes 37% of the company's revenue generation. Its majority revenue is expected to come from the Aged, Blind, and Disabled Medicare Department and Child Health Plan and Foster Care Department. The specialty service segment's revenue is expected to increase from $552 million in 2012 to approximately $780 million by 2014.

Source: Company's Press Release

This revenue growth has helped the company to move to the no. 303 position, moving up 150 positions from last year, in Fortune Magazine's list of America's largest companies by revenue. Its revenue grew from $5.3 billion in 2011 to $8.7 billion in 2012, helping it move up 150 positions.

Impact from introduction of ACA to the healthcare market

From January 1, 2014, every American should have a health plan either through their employer, Medicaid, or another source. In cases not insured, they will be fined and the fine amount will gradually increase by 2015, and even more by 2016.

This will benefit Centene with an incremental rise in the profitability of the company. Through the ACA, the company will be able to grow its core business, leading to a $20 billion revenue opportunity from its existing markets through 2016.

Acquisition of AcariaHealth

Centene acquired AcariaHealth, one of the United States' largest specialty pharmacy companies, in the first quarter of 2013 for $152 million. With this acquisition, the company aims at expanding its specialized pharmacy benefit services for diseases like Hepatitis C, Hemophilia, Multiple Sclerosis, and Oncology. AcariaHealth's specialty pharmacy platform will help Centene to become capable of serving its present and future clients, along with becoming the stand-alone pharmacy benefits management company. This acquisition will also benefit the company from AcariaHealth's strong relations with the pharmaceutical companies and broader access to the limited distribution of high-cost drugs. It has applied an integrated approach, as now it will easily provide high-cost specialty drugs to its client base of 2.7 million and also tap the highly acute population, which includes the aged, blind, disabled, and dual eligible.

With such prospects, Acaria alone is expected to contribute to the service revenue of the company with $250 million - $300 million.

Kentucky court case - a drag

In 2011, the state of Kentucky contracted three managed care companies: Centene's subsidiary Kentucky Spirit, WellCare, and CoventryCares. Here, Kentucky Spirit had the lowest bid, which resulted in a loss of $100 per month on every patient. The company was also provided with incomplete and erroneous information by the state, which in total has led Centene to losses of more than $120 million to date since the initialization of contract.

Therefore, Centene applied in the Franklin County Circuit Court in Kentucky, in October 2012, for an early exit from the Medicaid contract in July 2013, which is prior to the completion date of the contract dated July 5, 2014. According to the company, there was a provision for early exit where it would have to provide a prior, six-month notice.

But recently, the court ruled against Centene, stating that the company cannot terminate the Medicaid contract prior to its completion. The six-month notice will be counted valid only after the completion of the contract. For this, the court argued that if it had allowed such notice, then the state wouldn't have much time to confirm whether the company's clients have received adequate coverage from another Medicaid-affiliated company. If the company leaves the Kentucky Medicaid market prior to termination of the contract, it will be considered a breach of contract and the company will be liable to pay a penalty for the damages.

In such a scenario, Centene has two options looking forward. First, it can choose to breach the contract and leave at an early stage. As per section 39.11 of the contract, Centene will have to pay for the damages to the state, worth 10% of every month's capitated payment, which sums up to nearly $4 million every month. Looking at the contract time left, the losses can be expected between $60 million to $80 million.

Second, it can continue to operate as per the contract. The company has been facing losses of nearly $18 million to $20 million every quarter. With five quarters left for the contract, the company is expected to face losses of nearly $73 million. In other words, this loss will amount to approximately $1.03 per share if the company fulfills the contract as mandated by the court.

Either way, the company is subjected to an estimated minimum loss of $50 million to $60 million.

Texas rate hike

Centene is the biggest healthcare service provider in the Texas Medicaid managed-care market. It has a market share of nearly 25% in Texas. The company anticipates a rate hike for the Medicaid programs in the state. As per Texas HHS officials, the incremental rates are for the three-month quarter of the states' fiscal year ending August 31, 2013. The increasing rates are:

2.8% in the main Medicaid program called STAR

● 0.8% in STAR-Plus for acutely-ill patients

● 1.8% for children's program

These rate hikes will play an important role in boosting the expected premium and sales revenue of the company from the earlier estimated $10.1 billion to $10.4 billion for this year.

Bottom line

Centene, with an overall market share of nearly 3% to 4% in the Medicaid marketplace, is focusing on growth prospects through the initialization of the ACA and the expected rise in the number of citizens to be included in the plan for the coming years. It anticipates this marketplace to grow to nearly $250 billion by 2016. Based on the states the company presently covers, it sees a $100 billion opportunity market. Additionally, it expects a business opportunity through the ACA alone of approximately $20 billion.

All of these prospects can be fruitful on a long-term basis. For the near-term vision, it is difficult to find attractive opportunities that will boost the earnings side of the company.

I recommend a buy for the company for the long term.

Disclosure: I 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.