Should Investors Buy This Healthcare Giant?

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In August, the healthcare giant Aetna (NYSE: AET) announced plans to purchase Coventry Health Care (NYSE: CVH) for $5.7 billion. However, in an announcement earlier this week Coventry investors filed a lawsuit against the $5.6 billion takeover, saying that it unfairly enriches the company’s top executives while shortchanging Coventry investors.

The deal values Coventry Health at $42.08, with the company currently trading around $41.80. The premium on Coventry Health’s stock was 20% from the previous trading day. Coventry is expected to achieve strong future performance—revenues are predicted to be up 17% in 2012—with top line performance being driven by a Kentucky Medicaid contract that began in November, as well as additional Nebraska, Virginia and Missouri Medicaid contracts. These will help drive member growth, with an expected increase in 2012 of 36,000 Medicare Advantage and 373,000 Medicare Part D members.

Aetna joins its top competitors in a rush to break into the Medicare and Medicaid provider industry. Among Aetna’s biggest rivals are WellPoint (NYSE: WLP) and CIGNA (NYSE: CI). Both of these companies made key acquisitions within the past year to help give them more exposure to the Medicare-Medicaid industries.

WellPoint purchased AMERIGROUP for almost $4.5 billion, in a deal that makes the combined companies the largest private Medicaid enterprise by membership. WellPoint is expecting operating revenue to rise almost 2% in 2012, and operating EPS of $7.45 compared to 2011′s $7.00 total. However, the company’s CEO stepped down a month ago, in part due to several large investors being disappointed over company execution. AMERIGROUP is expected to increase premium revenues by 40% in 2012, driven by expansion in existing markets and entry into Louisiana, expansion in Texas and the May 1 acquisition of Health Plus. Health benefits costs are expected to rise to 86% of premium revenues (health benefits ratio), from 2011’s 83.7% mark.

Cigna purchased HealthSpring for $3.8 billion, which will build up the company’s Medicare business. The HealthSpring acquisition added about 365,000 Medicare Advantage and over 850,000 Medicare Part D members to Cigna’s member count. The company is expected to increase revenue 38% in 2012. The one downside to the HealthSpring acquisition was it has increased the firm-wide medical cost ratio. However, the company beat 2Q estimates by posting $1.49 EPS, versus estimates of $1.47, and saw its 2012 EPS estimates increased by $0.07.

The three pension funds listed in the Coventry Health lawsuit claim that the company’s board failed to shop around for the highest price. The funds are seeking a court order to block the deal from being completed, claiming that Coventry investors are only receiving a 20% premium while other recently-acquired insurers received over 40%. The WellPoint buyout of AMERIGROUP was at a 43% premium, while the Cigna acquisition of HealthSpring was at about a 38% premium.

If the takeover is completed, Aetna appears to have finally found what it has been looking for: a company that can give it exposure to government-based health plans. Aetna, primarily a commercial health insurance provider, would then have exposure to Medicare and Medicaid based plans through Coventry Health. By acquiring Coventry Aetna’s share of revenue from its government business would grow to over 30%, from its current level of 23%. The acquisition is expected to add around $0.45 to EPS in 2014 and $0.90 in 2015.

A 40% premium on the Coventry purchase would add another $1 billion to Aetna’s valuation. Although this might not be much for a healthcare giant like UnitedHealth (NYSE: UNH), which has a market cap in excess of $50 billion and over $11 billion in cash, it could be significant for Aetna. Aetna has a market cap of $13 billion (just over double that of Coventry Health), while Aetna has less than a $1 billion in cash. UnitedHealth also gained additional exposure to Medicare Advantage members through its February 2012 acquisition of XLHealth, which is expected to add 117,000 members—find out if UnitedHealth is a good investment.

This article is written by Marshall Hargrave and edited by Jake Mann. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of WellPoint. Motley Fool newsletter services recommend UnitedHealth Group and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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