Investors have been waiting for a large health insurer to announce a major acquisition. For weeks, a five-way scramble has been underway as insurers have sought out deals to make them bigger and more efficient, amid significant changes brought on by the Affordable Care Act.
Aetna (ticker: AET ) has bid on Humana ( HUM ). Cigna ( CI ) has rejected offers from Anthem ( ANTM ). And even United Health has reportedly approached Aetna.
But Centene ( CNC ) snuck in and stole the limelight, announcing Thursday a $6.8 billion stock-and-cash deal for Health Net ( HNT ), a move that makes it one of the nation’s largest Medicaid-focused health insurers and grants it entry into the Medicare market.
Wall Street wasn’t impressed, however. While Health Net’s share price has surged more than 17% today to a recent $76, Centene has fallen 6.5% to $75.65, reversing the pre-market gains amid worries that Centene is sacrificing topline growth to acquire scale.
And Leerink analyst Ana Gupte sees UnitedHealth possibly sweeping in with a competitive offer for Health Net.
Regardless, today’s news has refocused Wall Street’s attention on the Medicaid market, the fastest-growing segment of the health insurance industry. And Centene’s selloff may offer a buying opportunity.
“There is still a lot of growth opportunity,” says Sarah James, an analyst with Wedbush. “Centene could have multiple upward revisions to consensus as they move toward a 2% net margin in 2017. That is significant margin growth for them. I also see a company with the potential to grow revenue 50% to 100% over 10 to 15 years.”
Barrons.com has been optimistic on Medicaid health insurers for some time, at first citing the growing demand among cash-strapped states for help managing Medicaid programs. Now, the Affordable Care Act is fueling the biggest expansion in the history of the Medicaid program.
With $22 billion in revenue and 4.4 million members in 23 states, Centene is one of three publicly traded stand-alone Medicaid-focused insurers, competing with rivals Molina (MOH ) and WellCare Group ( WCG ). Takeout speculation has swirled around this group for years.
The Health Net deal, expected to close in early 2016, creates a company with pro forma 2015 revenue of $37 billion and six million members. It is expected to generate synergies totaling $150 million within two years and add 10% to per share profit during the first year.
Current consensus forecasts compiled by sell-side analysts show Centene growing per-share profit 25% to $2.78 this year then 17.6% to $3.27 next year.
That growth and takeout speculation has fueled a more than 600% return for Centene investors over the past five years, making it the best-performing name among the health insurance stocks tracked by Thomson Reuters. It is also the most expensive, trading at almost 28 times forward earnings.
But none of the Medicaid-focused insurers are cheap. All three trade above 20 times forward earnings — the cost of rapid growth and lingering takeout hopes.
Budget cuts could devastate already tight profit margins, as could a big jump in medical costs. There is fierce competition for Medicaid contracts, and more federal regulations ahead.
Wedbush’s James argues that Centene is now well positioned to go after $40 billion to $47 billion in Medicaid contracts going out to bid in the next one to three years.
In short, Centene still makes sense.
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