Health Insurers' Merger Mania On Hold?Commentary by John R. Graham
July 22, 2015
Just a few weeks ago, it was declared that a great pent-up demand for mergers and acquisitions among health insurers would unleash itself as a result of Obamacare’s confirmation by the Supreme Court. And so it did, for a while at least. Today, the consolidation seems less sure.
In 2011, two deals (Cigna CI -0.66%’s acquisition of Health Spring and Aetna AET +0.00%’s purchase of Coventry Health Care CVH +%) were worth $9.5 billion. Today’s three pending deals are much larger, amounting to almost one hundred billion dollars.
However, all three of the deals announced recently are looking a little shaky. Investors appear to have lost confidence that these combinations will take place. There is no real news suggesting the business case for a more consolidated health insurance industry is misplaced. Fear of government preventing the tie-ups is the most likely concern. Let’s look at the latest status of these three deals.
Only five weeks after putting itself up for sale on May 29, Humana HUM -0.54% announced a friendly take-over by Aetna on July 3, valued at $37 billion. Aetna announced an acquisition price of $230, comprising $125 cash and 0.8375 shares of Aetna common stock. The companies announced that this was a 29 percent premium to Humana’s unaffected stock price.
The stock prices at the close of the first trading day after the announcement indicated a return of 18 percent (including $0.40 net dividend per Humana share) for investors who shorted the spread (buying Humana stock and shorting Aetna stock), anticipating the acquisition would close in about one year. As of the close of trading yesterday – more than two weeks after the announcement – the spread indicated the same extremely high rate of return. This indicates investors believe there is a very significant risk the deal will not close.
Other deals had a more enthusiastic initial response, but have also been losing investors’ confidence. Apparently after weeks of fruitless negotiations, Anthem made hostile $53.8 billion bid for Cigna on June 20. Although we have less information on this deal (because it is hostile), Anthem stated its offer of $184 per share of Cigna consisted of 31.4 percent Anthem shares and 68.6 percent cash, which implies $126.22 cash and 0.35 Anthem shares. Anthem announced this was 35 percent premium to Cigna’s unaffected closing stock price on May 28, presumably the date when Anthem made its initial offer to Cigna’s board.
On June 22, the first trading day after Anthem publicized its bid, the closing stock prices of the two firms indicated a return of about 13 percent for an investor who bought Cigna and shorted Anthem (including a net short dividend of $0.75 per Cigna share), anticipating the acquisition would close in one year. Yesterday’s closing stock prices indicated a wider spread of 17 percent, reflecting investors’ heightened concerns that the takeover will not succeed.
Finally, Centene announced a friendly takeover of Health Net for $6.3 billion on July 2. Comprising 0.622 shares of Centene plus $28.25 cash for each share of Health Net, the premium was 21 percent of Health Net’s unaffected stock price. Investors initially attributed very little risk to this takeover. By the close of trading on July 2, the spread indicated a return of just 4 percent, anticipating the acquisition would close in one year. Yesterday’s closing stock prices indicate the spread has more than doubled, to 10 percent.
There is no precise news that suggests why investors are less confident that these deals will proceed. Some market watchers suggest that any one of them could be disrupted by another large insurer, especially UnitedHealth Group making a bid for one of the acquirers.
That is certainly plausible. However, it is more likely that investors have decided that the risk lies in the regulatory and political realm. As we enter deeper into the next electoral cycle, insurers will surely become higher profile targets of criticism for their double-digit Obamacare rate hikes, continuing inability to provide quality and price transparency tools that consumers value, and difficult relationships with doctors and other providers.
Allowing health plans to collapse into an oligopoly is not something any politician of either party would want to see happen. Health plans have enjoyed a very good run since the Affordable Care Act was passed, but it looks like the next stage of their business plans will be harder to execute.