Just Might Work

Walmart-Humana Sounds Wild, But Makes Sense

It's a good strategic fit for the retailer and isn't a huge financial lift.
Photographer: Scott Olson
WALMART INC
+0.64
At Closing, April 25th
87.17 USD
HUMANA INC
+3.44
At Closing, April 25th
297.39 USD

As if the health-care-merger frenzy weren't wild enough already, it looks as if Walmart Inc. may soon dive into it.

The mammoth discount retailer is reportedly in early-stage talks to acquire Humana Inc., a health insurer valued at $41 billion (based on Thursday's after-hours trading price, which spiked on the late news).

The potential merger comes on the heels of a December offer from drug-store chain and pharmacy-benefits manager CVS Health Corp. to buy insurer Aetna Inc. for $77 billion including debt -- and we mean a lot of debt (more on that later). There was also the $67 billion merger announced this month between Cigna Corp. and Express Scripts Holding Co., a similar pairing.

In Play

Humana has drawn takeover interest from Walmart as Amazon's impending move into health care triggers defensive dealmaking in the industry

Source: Bloomberg

Note: Hypothetical bid price assumes 30% premium to unaffected closing price March 29.

Driving all this dealmaking is the fact that Amazon.com Inc. -- a recent target of ire for President Donald Trump -- has its eye on health care. It struck an alliance in February with Warren Buffett's Berkshire Hathaway Inc. and JPMorgan Chase & Co. to tackle employee health costs. The trio's initial focus will be on their workers, but the threat of Amazon even dipping its toe into the industry has the biggest players scrambling to respond.

Bloomberg News reports the Walmart-Humana talks are about deepening an existing partnership, and that while a merger is among the options being explored, an outright combination isn't likely at this point. Given Walmart's sizable pharmacy presence, getting hold of Humana's pharmacy-benefits management (PBM) business would be appealing, though.

Humana is by far the largest PBM remaining for potential suitors and could help Walmart keep drug costs down. It already manages $26 billion in annual enrollee and client drug spending.

Humana also has the second-largest Medicare presence of any insurer, fitting nicely with Walmart's customer base. Some of Humana's Medicare Part D enrollment actually comes from a partnership with Walmart -- the two companies offer a co-branded drug plan that drives traffic to Walmart stores. 

New Territory

Buying Humana would put Walmart into some less familiar lines of business, but the Medicare piece does fit with its retail and pharmacy customer base

Source: Walmart's 10-K filing for fiscal 2017

Buying Humana would help Walmart attract even more enrollee traffic and drive patients to its in-store clinics. It would boost revenue and give Walmart a captive customer base -- all of which will help it fight Amazon on the retail and grocery fronts. 

One of Albertsons Cos.' selling points for its acquisition of Rite Aid Corp. in February was that its pharmacy customers were especially big spenders, even net of their drug purchases. The same may be true for Walmart. And don't discount Walmart's potential savings from managing health benefits for its 1.5 million employees more directly and entirely in-house. 

Of course, all of this comes with caveats. Walmart would have to learn a lot about health care on the fly -- managing one of the country's largest health insurers is very much not its specialty. And insurers and PBMs aren't exactly well-loved by consumers. Walmart sending big insurance-premium bills or telling people what drugs or doctors they can't use might not favorably dispose people to shop there.  

Like CVS, Walmart would also be buying at the top of the market. Before news of the deal, Humana shares were within reach of their record closing high of $291.23, set on Jan. 29. The stock's forward EV/Ebitda multiple as of Thursday's close was already at a 27 percent premium to its two-year historical average. Meanwhile, Walmart's valuation has been in retreat, which probably helps explain its sudden interest in major acquisitions. 1

Market Appraisal

As Walmart's valuation has started to deflate, possible target Humana has gained ground

Source: Bloomberg

Still, the math behind a Walmart-Humana deal is far less jarring than CVS-Aetna's was. Walmart's balance sheet is pristine and its credit rating is tops. Let's walk through some hypothetical deal terms: Assume Humana would command a typical 30 percent takeover premium to its unaffected trading level. That puts an offer at about $350 a share. Walmart could pay all cash and the deal would lift earnings, even before even factoring in any synergies. 

More important, Walmart's net leverage would only climb to a manageable ratio of 2.3 times Ebitda. And while Walmart and CVS's new borrowings for the transactions and added Ebitda post-closing would both be in the same ballpark, Humana brings an almost $9 billion net cash position with it. 

Side by Side

Using some back-of-the-envelope math, Walmart's potential takeover of Humana may have more financial merit than the debt-heavy merger of CVS and Aetna

Source: Bloomberg, Gadfly analysis

The real question is how the Trump administration and government regulators feel about these large-scale vertical mergers. Would Trump's hatred for Amazon and Jeff Bezos come into play? Fears of a Trump bias have already affected one megamerger being hauled before a judge (AT&T Inc.-Time Warner Inc.).

In any case, Walmart has its work cut out for it with a Humana deal. But the strategic rationale is there, and the financials aren't too disconcerting.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Walmart's largest transaction to date was the roughly $11 billion it paid in 1999 for Asda, a British supermarket chain.

To contact the authors of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net
Max Nisen in New York at mnisen@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net

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