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One deal too many for UnitedHealth?
Its agreement to acquire PacifiCare looks too much like a deal just to do a deal. But it could spur takeover interest in some smaller companies in the sector.
By Robert Walberg
When I heard Wednesday about UnitedHealth's (UNH, news, msgs) agreement to buy PacifiCare Health Systems (PHS, news, msgs) for $8.1 billion, the first thought that crossed my mind was the famous Ronald Reagan quote, "There you go again."
Within the last two years UnitedHealth has swallowed 10 companies, including Oxford Health for $5 billion and MidAtlantic Medical for $2.7 billion. Growth through acquisition isn't necessarily a bad thing, especially in a scattered industry such as health care, but acquisitions for acquisitions sake are never a good idea.
Though UnitedHealth's CEO, William McGuire, has stated in the past that "it's dumb" to do big deals just to do big deals, you have to wonder whether this deal was done largely to appease Wall Street's insatiable appetite for growth. If nothing else, the timing is suspicious, as the deal now makes the upcoming quarterly earnings report a nonevent. For those with short memories, UnitedHealth's stock took a brief hit after the company disappointed investors with its first-quarter numbers.
Again, McGuire would like us to believe that "this is not a transaction that either company really needed to do." Excuse my cynicism for a moment, but when CEOs go out of their way to say this isn't a deal for the sake of making a deal my first thought is that's exactly what just went down. Now I might be totally wrong in that assumption, and from all early indications the investment community loves this deal. And on the surface what's not to love?
Climbing back up
In acquiring PacifiCare, UnitedHealth once again will become the nation's leading health care provider in nearly every measure except total members, where WellPoint (WLP, news, msgs) still holds the lead with about 28.5 million. WellPoint assumed that lead when it acquired Anthem last year. In adding PacifiCare's 3 million members to its total of 23 million, UnitedHealth will fall just shy of WellPoint's total. However, in terms of total revenues and market cap, UnitedHealth is again No. 1.
But if this deal isn't just about being bigger, then what's it about? Well, in addition to the added efficiencies, UnitedHealth achieves three main goals through this acquisition. First and foremost, it increases the company's exposure to the Medicare HMO market. A few years back, health insurance companies couldn't get far enough away from Medicare, but in the aftermath of the Bush reforms, this is now seen as a growing profit center.
Considering that PacifiCare generated roughly 40% of its revenues from Medicare, it was a natural fit to gain exposure to this market. However, this might be one of those times when UnitedHealth wants to be careful what it wishes for. Linking your company's growth prospects to any government-funded program is always a dicey proposition because what's well funded today might be less so tomorrow when a new leader assumes office. This is especially true at a time of record deficits.
Another questionable advantage of this deal is UnitedHealth's expansion into the West Coast. Most of its earlier deals, especially the two big ones for Oxford and MidAtlantic Medical, were designed to secure the Midwestern company's dominance on the East Coast. Now, this deal is being trumpeted as UnitedHealth's move to go national because it'll significantly increase its membership in California.
A volatile state
Now California is a great place to go for sun and fun, but it can be a volatile state to do business in. Not only does the state have serious financial problems, but also it's known for its citizen-led referendums that often wreck havoc on businesses. When it comes to the health care business, the state's premiums have traditionally run well below the national average, though the gap has been closing in recent years. Nevertheless, adding exposure to the California market isn't without concern, at least not to those who read beyond the deal's splashy headlines.
Finally, this deal is also being hailed as winner because it bolsters UnitedHealth's burgeoning exposure to the fast-growing area of consumer-directed health plans. These plans combined relatively high deductibles with a form of savings plan. As the cost of insurance continues to rise, and more and more individuals are left to fend for themselves in acquiring insurance, these plans are seen rising at a relatively rapid pace. With over 1 million members already enrolled in such plans, UnitedHealth is a leading player in this area and it obviously plans to build on that position.
While the future of the industry may indeed be pointed in the direction of consumer-directed plans, diving head first into the marketplace brings with it some added risks. The savings element of these plans is expected to draw new competitors to the marketplace, such as banks and money managers. Additionally, these plans require a new set of skills not only in terms of sales but plan management. Will UnitedHealth's success in the past with more traditional plans translate into this arena? Maybe, but maybe not, especially given the added competition.
On the surface, this looks like a victory for UnitedHealth and Wall Street is likely to treat it as such, at least at first. PacifiCare gets folded into a much larger operation that secures its future, while UnitedHealth adds members in some targeted growth areas, gains geographic reach and reduces costs through synergies. If the deal lives up to early management and Street expectations, it'll bolster UnitedHealth's earnings by 5 to 6 cents a share within the first year and help the company achieve growth of at least 15% in 2006.
Other acquisition candidates
The news should also spark interest in some of the smaller remaining health care companies such as Humana (HUM, news, msgs), Coventry Health Care (CVH, news, msgs) and Health Net (HNT, news, msgs). Quite frankly, if you're considering investing in the managed health care industry, this is the place to look as consolidation is likely to continue, especially as companies like Cigna (CI, news, msgs) and Aetna (AET, news, msgs) feel the pressure to get bigger to compete with UnitedHealth and WellPoint.
As far as UnitedHealth is concerned, investors should be concerned that the torrid buying spree will catch up with it. The bigger a company gets, the harder it is to maintain high double-digit growth, a growth rate Wall Street has come to expect from UnitedHealth. In addition, integrating all the various parts can create problems.
UnitedHealth has enjoyed tremendous success in the past with its growth-through-acquisition strategy but adding significant exposure to Medicare and California might not look as good tomorrow as it does today. And at nearly 22 times estimated earnings, there's no room for disappointment.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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