Health Insurers Trapped by Need for Growth
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Editor's Note: WellPoint purchased Resolution Health, not Revolution Health. This version has been corrected.
Health insurers are trapped by a need for growth. Without growth in insureds, in patient count, they can depend on shrinking margins and stock prices. So everyone is buying access to patients, and technology that can help them serve those patients for less, knowing that health reform is not going away.
Under the Affordable Care Act, insurers must spend a certain portion of revenues on patient care, or refund the difference. The idea is to reduce incentives for refusing treatment, and to encourage per-patient fees rather than fee for service. This puts a lid on potential earnings growth, which can only come now by getting bigger.
I covered health IT for ZDNet during the ACA fight, and what I found was that insurers, who were previously just buyers of services from vendors like General Electric and Siemens, were increasingly looking to build their own software suites in order to maintain competitiveness. While they fought the war, they knew they would become the primary beneficiaries once it passed, and they're now pressing that advantage.
During the last year insurers began moving into this new business model, with some success. Further growth depends on expanding both the number of patients covered, and the control they have over how services are delivered.
United Health Looks Overseas
But it's not relying strictly on the U.S. for further growth. Instead, it is buying Brazil's Amil Participaceos. It took a 65% stake last year and plans to buy another 25% in the public market. That meant foreign revenues of $1 billion for the fourth quarter, still just 5% of the total, but it's a big world out there.
Before the Brazilian deal United's growth was based largely on health IT, which it reorganized into Optum. The idea behind groups like Optum, beyond getting access to stimulus cash offered by the 2009 Recovery Act, is to enforce best practices, which it's getting through a recent link to the Mayo Clinic, which has used an integrated approach to keep costs well below industry averages while maintaining a high quality reputation.
The company also benefits from media confusion, the difference between what it says rhetorically and what it says with its numbers. A Reuters headline on its fourth quarter results said “costs were low and revenue rose,” while a Marketwatch headline on the same story claimed “net falls 1.1% on more medical costs.”
Aetna Buys Care
Aetna (NYSE: AET), like UNH, is reaffirming its earnings guidance within a narrow range, with earnings of $5.25-$5.80/share. It can do this because its scale is making revenue and earnings streams more predictable. Set this earnings estimate against a stock price of $45.40 would make it a screaming bargain, especially with a dividend yield of 1.75% on top of that.
To get predictable earnings the company, again like UNH, is scaling. Its acquisition of Coventry, announced in August, follows an industry trend of buying into serving Medicare and Medicaid patients, even while condemning the government's expansion into that space. With the Coventry deal completed, Aetna will get 30% of its revenue from that sector.
What Medicare and Medicaid offer companies like Aetna are both huge flows of cash and the chance to enter the per-patient business model, in which the goal is to keep people out of the hospital rather than to load up on services. By scaling up into this business, the insurers hope to also be able to bargain with Congress on reimbursements, fighting the efforts to squeeze budgets by having control over the patients.
WellPoint Seeks Wellness
It also got into Internet wellness by buying Resolution Health.
There are two key ideas here. First, as with Aetna, WellPoint wants to scale into taking government dollars and controlling millions of captive customers. Second, the company needs “big data” and full automation of patient records in order to force doctors to follow protocols that work best and cost less. This is a feature of the Affordable Care Act, not a bug meant to enrich insurers.
The success of health insurers in managing and integrating large acquisitions will make the difference between those companies you should be invested in and those you should be avoiding, except as acquisition bait. Over the last year only AET has eked out a stock price gain of 4%, while the whole sector maintains earnings multiples in the high single-digits, equivalent to the weakest banks and major manufacturers.
At some point, the steady earnings here will turn into dividend expansion, but there remains some consolidation to go before that happens. The three companies discussed here are all likely to survive that consolidation. The rest of the sector is ripe for a buy-out.
DanaFBlankenhorn has no position in any stocks mentioned. The Motley Fool recommends UnitedHealth Group and WellPoint. The Motley Fool owns shares of WellPoint. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!