A Merger Wave Hitting Health Care. If you can't beat 'em, join 'em

That all we need now, hospitals too big to fail! ---BBB

OCTOBER 30, 2011
A Merger Wave Hitting Health Care
By ROBIN GOLDWYN BLUMENTHAL

If you can't beat 'em, join 'em.

Big managed health-care companies are starting to take that idea to heart.

These insurers, which try to coordinate patients' medical providers to keep a lid on costs, are facing the double whammy of market saturation and margin-squeezing health-care reform.

As a result, giants like Aetna, Cigna and Humana have started snapping up smaller players to keep earnings growth alive.

Last week, Cigna said it would pay $3.8 billion to buy HealthSpring , giving it a foothold in the senior-citizen and Medicare markets.

With the baby boomers starting to retire, "this is an attractive growth market," says Matt Manders, president of Cigna's service, clinical and specialty businesses. "We will continue to look for avenues to further our growth strategies." Cigna expects the deal will increase its earning per share in the first year.

Also last week, Amerigroup , a big Medicaid insurer, said it would pay $85 million to acquire Health Plus, a New York operator with 320,000 members.

The Cigna deal boosted HealthSpring's share price by 33%, and bolstered the stocks of other managed-care companies, which have been trading at about nine times expected 2012 earnings—some 25% below the multiple of the Standard & Poor's 500-stock index.

Some sharp investors think smaller companies like Coventry Health Care and Health Net could soon become targets, along with Medicaid specialists like Centene, Molina Healthcare and even Amerigroup.

The action, these investors say, could lift some of the targets' stocks by more than 50%.

"We're on the verge of a massive amount of M&A [mergers and acquisitions]," says Jim Lane, a Westfield, N.J., money manager. "There's no organic growth left in this business except for pricing."

Membership in managed-care plans offered through employers has fallen 5.4% from its 2000 peak, to 169.7 million people in 2009, the most recent year for which data exist, according to the U.S. Census Bureau.

Today's sluggish job growth doesn't bode well for improvement. While earnings at Aetna (mostly a managed-care insurer) are expected to climb just 2%, and those at Cigna, 6%, Coventry's profits look set to rise by about 10% this year and Health Net's, by 7%. Health Net declined to comment. Coventry couldn't be reached for comment.

The biggest unknown for the industry is health-care reform. The law proposes that those without insurance will, by 2014, be covered by "health exchanges." The remainder of the population will either have private health insurance or get coverage under Medicaid or Medicare.

If the Supreme Court overturns the health-care law, managed-care stocks would get a boost, says Dave Shove, who follows the industry at BMO Capital Markets in New York. But if the law stands, "that definitely favors local scale," says Mr. Shove, providing further impetus for consolidation.

Robin Goldwyn Blumenthal is a senior editor of Barron's.