Health Net Appeal Grows as Obamacare Takes Off: Real M&A

After adding $1 billion in market value this year, Health Net Inc. stands to gain even more for shareholders in a takeover.

The health-care provider that primarily serves the West Coast is benefiting from the success of public exchanges in California, where Obamacare has been adopted faster than other parts of the country. Sterne Agee Group Inc. says that market makes Health Net “ripe for the picking,” and analysts estimate the $3.4 billion company could get about $60 a share in a takeover, a 43 percent premium to last week’s close.

Profits are forecast to shrink or slow for many U.S. health-care providers next year, which may lead to mounting pressure to do deals. Large providers such as Aetna Inc. and Humana Inc. will probably look to California to find acquisitions, according to Leerink Partners LLC. While Health Net’s stock rallied 42 percent this year, the Woodland Hills, California-based company would still be a bargain, as it trades at one of the lowest sales multiples of its peers, according to data compiled by Bloomberg.

“The biggest thing for Health Net is their California government exposure,” said Joshua Schachter, senior portfolio manager and principal at Snow Capital Management LP, which owns shares of Health Net. Large, managed-care companies “would love these members,” he said of Health Net’s customer base.

Brad Kieffer, a spokesman for Health Net, declined to comment.

California Gold

Health Net provides coverage to 2.6 million people in California, Arizona and parts of the Northwest, and it has plans tailored to Latino communities in California. Chief Executive Officer Jay Gellert has said the company could be an attractive target for providers seeking a piece of the growth from President Barack Obama’s Patient Protection and Affordable Care Act of 2010, according to Leerink.

About 1.4 million California residents signed up for coverage under the new health-care law as of March 31, almost three times the amount expected and more than any other state, according to enrollment updates from California’s Department of Health Care Services. Health Net captured some of that burgeoning market because it’s one of 12 companies involved in Covered California, the marketplace for health-care plans in the Golden State.

“The California market is one of the most, if not the most, advanced with regards to implementation of the Affordable Care Act,” Brian Wright, a New York-based Sterne Agee analyst, said in a phone interview. “Because of that, you’ll probably see the shift from employer-sponsored insurance earlier than you will in other markets.”

Wright said Health Net may be able to get $60 a share in a takeover. The stock closed at $41.90 last week.

Today, Health Net climbed 1.8 percent to $42.64.

Growth Key

National health-care providers are seeking to tap into growth from the Affordable Care Act and that means looking toward medium-sized targets such as Health Net, said Ana Gupte, a New York-based analyst with Leerink Partners LLC.

“They’re all positioning themselves to be in these high-growth markets and develop a very efficient cost structure, and usually acquisitions can get you there faster,” Gupte said during a phone interview. In California, “there’s a very large Medicaid population, the exchanges are popular.”

Buying In

Aetna and Cigna Corp., the third- and fourth-largest U.S. insurers, respectively, are both underexposed to Medicaid, the government-sponsored health plan for low-income families, according to Chris Rigg, a New York-based analyst with Susquehanna International Group LLP. That makes Health Net an attractive target for both companies because so many of its customers participate in the program, Rigg said.

While 49 percent of Health Net’s members are enrolled through Medi-Cal/Medicaid, only about 9 percent of Aetna’s total members and less than 1 percent of Cigna’s are enrolled through Medicaid, according to company filings.

For such national-plan providers, “the path of least resistance may be to buy your way in,” Rigg said.

Profit growth at Hartford, Connecticut-based Aetna and Bloomfield, Connecticut-based Cigna will slow in 2015, according to analysts’ estimates compiled by Bloomberg. Health Net is scheduled to report second-quarter earnings results this week.

Humana Sense

Humana, based in Louisville, Kentucky, is an $18 billion health-care company with almost no presence in California, making it another ideal acquirer for Health Net, Gupte said. Because California restricts the number of providers it allows on its exchanges, the only way Humana could get access to the state is through an acquisition, she said.

“California’s a tough state from a regulatory perspective,” Gupte said during a phone interview. “Humana at some point would want to enter California. They’re not here in California, and it’s not possible to do it organically.”

Representatives for Aetna and Humana declined to comment. A representative for Cigna didn’t respond to requests for comment.

Health Net plans to announce a cost-cutting initiative that will target its general and administrative expenses, which have ballooned in the last few years.

Snow Capital’s Schachter said he hopes the company opts to be bought out instead of trying to outsource its back-office operations -- an option Health Net has been considering.

“The best thing to do would be to sell the company to a Humana or United or even an Aetna, someone that’s looking to get more scale and more members in Health Net’s markets,” said Schachter, who’s firm manages about $4 billion. “This stock would fit very nicely into someone else’s portfolio, and they’d be able to take out a lot of costs at the same time.”

Acquisition Deterrent

A potential acquirer may balk at the idea of buying Health Net if it can’t squeeze out cost synergies because they’ve already been outsourced.

“If they do this outsourcing deal, we’ll have to see what that means for anybody who tries to acquire them,” Gupte said. “Are they locked into this deal? Is there a clause that gets them out of it?”

Schachter, who also estimates a $60 takeover price, said Health Net is still attractive to national plans now because the company has already reviewed where it could scale back, making such cuts easier to execute for potential acquirers.

If a national-plan provider can sign a deal before Health Net finalizes plans to outsource its back-office expenses, the planned savings would just become synergies, Susquehanna’s Rigg said.

Whether the company cuts costs on its own or chooses to pursue a sale, investors are anxious to see it make a move, Schachter said.

“Reading between the lines, it could be a takeout or it could be a G&A outsource agreement,” he said. “Either would be a big development for the company’s bottom line.”

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