How to Play the Healthcare Plan Market

David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The bad news is that uncertainty in the healthcare plan market has added risk to investor portfolios. The good news is that large healthcare firms have taken advantage of the environment by scooping up undervalued businesses in a frenzy of takeovers. In my view, the best takeovers in managed care will come abroad and away from US government programs. Some producers have taken this same attitude while others have diverged. Still others have failed to add on "accretive" value in acquisitions, period. Below, I review some of these healthcare firms and explain which ones I think are undervalued.

UnitedHealth Group (NYSE: UNH) Eyes Latin America For Share Gains

While the stock has virtually kept up with the S&P 500 over the last 12 months, the last six months have been disappointing. However, I am optimistic about the next six months and even the few years ahead. After the $4.9 billion 90% buyout of Brazilian Amil Participacoes, the company has gained dramatic exposure to a high-growth emerging market. Amil is not a small name, but rather the largest Brazilian healthcare company. Around 50 million individuals, or just one-fourth of the population, have managed care, so the potential for expansion is considerable and should drive shareholder value.

With so much uncertainty in the US healthcare system following the SCOTUS ruling on the Affordable Care Act ("Obamacare"), UnitedHealth offers an attractive way to hedge against domestic headwinds. Amil runs 20 acute care hospitals and generated close to $5 billion in the top-line last year. Unfortunately, the company has underperformed in terms of increasing membership, so the business was undervalued enough to make the acquisition accretive. It should also be noted that the founder of Amil, Edson Bueno, is a billionaire who will be joining the board. That kind of intellectual capital should hold the multiples up in their premium level.

At a respective 11.7x and 10.3x past and forward earnings, UnitedHealth is trading at a premium for healthcare plans (which is saying something about how cheap the sector is overall). Analysts rate the stock a 1.8 out of 5, where "1" is a "buy."

Aetna (NYSE: AET) & (NYSE: WLP) Look Towards US Government Programs

Aetna and WellPoint also make for attractive investments. They are trading at bargain multiples of 9.3x and 7.6x past and forward earnings for Aetna and 8.4x and 7.7x for WellPoint. The latter is forecasted for 10.1% annual EPS growth over the next five years, which is 20 bps less than what is forecasted for Aetna. The difference is not particularly meaningful given uncertainty in healthcare plank - and adding to that point is how they are both rated 2.1 out of 5 on the Street.

Like UnitedHealth, Aetna also made a large acquisition in the form of Coventry. However, this $5.7 buyout does not offer international expansion; rather, it will help the company add 5 million customers to its already expanding patient population. In addition, the patients will mostly go to federal health programs whose futures are largely uncertain: Medicare and Medicaid. Aetna made the deal in an effort to take care of the Affordable Care Act's expansion of Medicaid. However, in my view, the upside was already factored into the stock with little concern for broader secular trends. Analysts anticipate the deal closing in mid-2013. In the meanwhile, debt will soar 900 bps to 40% of market capitalization.

WellPoint took similar action to expand in Medicare and Medicaid through buying out Amerigroup for $4.9 billion - a deal that, again, exposes shareholders to considerable uncertainty. Amerigroup has delayed the shareholder vote by two weeks to Oct. 23 after a shareholder lawsuit against the board. While I am not optimistic about the acquisitions of WellPoint or Aetna, I believe that the stocks are discounted enough to outperform. In addition, increasing scale generates substantial synergies in managed care, since it enables fixed costs to be spread out through economies of scale. 

Moreover, the fundamentals of both look strong. WellPoint, for example, has generated strong cash flow while being very conservative in capital expenditures. With the stock at a discount to tangible book value, share buybacks are particularly accretive to EPS. Aetna has also started to beat analyst expectations after a disappointing 1Q12 and is tracking well enough to expand multiples at least to historical levels.

TakeoverAnalyst has no positions in the stocks mentioned above. 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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