Description

Business

• Health care insurance provider that is roll-up of the US Blue Cross Blue Shield branded plans

• Commercial insured = 55%

• Government (Medicare, Medicaid) = 20%

• Self-funded plans (ASO) = 15%

• Individual = 10%

• Employers and customers pay a fixed monthly payment in exchange for ANTM covering their health care expenses

• Typically, ~ 80% to 85% of premiums are spent on health care expenses

• Value-add

• Insurers have local oligopolies that enable them to pressure health care providers (e.g., hospitals, physicians, pharma companies) to provide services for cheaper

• Insurers manage patient populations to lower utilization, which is possible given 5% of the population accounts for 50% of health care expenses

• Competitive Advantage

• Blue Cross Blue Shield has a strong brand name

• ANTM believes it can price 1% above peers (and thus gain a 1% greater margin than peers, which is meaningful given margins are only MSD%), and still maintain share b/c of the Blues brand name

• Cost advantage given scale enables negotiating leverage vs providers

Thesis

ANTM trades at a discount to (1) peers and (2) EPS growth potential, given concerns over ANTM’s commitment to Obamacare’s largely money-losing Exchanges.  However, what the market is missing is that (1) ANTM has a cost and brand advantage in the individual market, and so can make Exchanges profitable even while peers may not and (2) if the Exchange is unsuccessful for ANTM in the medium term, ANTM may simply exit the Exchanges, and so possible Exchange losses should not be capitalized

• ANTM trades at a Forward P/E of 11.5x

• vs 14.4x for AET, despite AET and ANTM growing EPS at the same % rate

• vs 14.2x implied by ANTM’s historical discount to the market

• vs ANTM EPS growth of 10% to 15%

• Valuation is depressed b/c ANTM has been the most vocal about being committed to Obamacare’s Exchanges

• Exchanges are marketplaces (created by Obamacare) where individuals who do not receive insurance from their employer can buy health care insurance, with the help of a government subsidy

• Exchanges have been unprofitable for insurers b/c:

• Members more sick than expected gravitated to the Exchanges, given the “stick” to get healthy members to join Exchanges was not onerous enough

• The “stick” of an individual mandate payment of $325 per adult/ $975 per family per year is not enough to incentivize healthy individuals to buy insurance.  Additionally, there are ways for individuals to avoid paying the individual mandate

• Insurers can’t deny members for pre-existing health conditions, and so can’t offset the lack of healthy members by denying sicker members coverage

• Customers can buy insurance after they get sick based on “special enrollment periods” that only require a flimsy excuse to request insurance

• This defeats the purpose of insurance, and led to customers signing up only after they were sick, leading to much sicker patient populations than expected

• Difficult for insurers to raise prices enough to offset these sicker members’ costs given (1) the potential to trigger an insurance “death spiral” and (2) state regulations that monitor price increases

• A death spiral is the risk that premiums increase enough to cause only exceptionally sick members to enroll, leading to even lower profitability for the insurer.  Raising prices too quickly can lead to this death spiral.

• Price increases above a certain level must be approved by state authorities, which keeps pricing in check

• Gov’t promises of risk mitigation payments were not paid to the insurers

• Exchanges account for MSD% to HSD% of health care insurers’ revenues, and are -MSD% margin unprofitable

• ANTM’s health insurance peers have said they would walk away from providing insurance on the Exchanges in ‘17

• AET, UNH and HUM have all suggested they would leave a material number of their state Exchanges, given the structural issues outlined above

• However, ANTM has remained committed to the Exchange business, saying it has no plans to exit

• Concerns over ANTM remaining in the Exchanges and assuming accelerated/material losses are unjustified, given (1) ANTM has a cost advantage vs peers and (2) if ANTM found itself losing money over a long period of time, it is allowed to exit the Exchanges just like its peers

• ANTM is the only insurer who was breakeven on the Exchanges in ‘15, while all others had negative -MSD% to -HSD% margins

• ANTM was able to be breakeven b/c ANTM has a ~4% margin competitive advantage vs peers

• 3% due to lower costs, given higher market share in the individual market due to its Blues brand name

• 1% pricing advantage due to brand value

• As others exit the Exchanges, it only improves ANTM’s chances of making the Exchange business profitable

• ANTM would not commit long term to the Exchange if it does end up being chronically unprofitable

• ANTM is likely only committing through ’17 b/c it wants to be viewed favorably as it attempts to win its antitrust case to purchase CI

• ANTM’s current stock price implies ANTM is permanently committed to the Exchange business, and that losses on the Exchange will accelerate to the downside.  Given ANTM’s ability to exit the Exchange, and given ANTM’s cost advantage that historically has made ANTM’s Exchange business breakeven to slightly profitable, this implication seems exaggerated.

There is no value being ascribed to ANTM winning concessions from ESRX, which could add ~1.40 per share in earnings.

• ANTM believes that ESRX is overcharging ANTM for their pharma purchases

• ESRX purchased ANTM’s PBM in ’09, and at the same time penned a 10 year agreement between them.  

• Supposedly, part of this agreement suggested ANTM would pay higher prices for its pharmaceuticals in exchange for a $5bn upfront payment.  However, ANTM argues it is paying above what was agreed.

• Given ESRX claims that it sent proposals to renegotiate drug savings of $2bn+ for ANTM, but that ANTM rejected these proposals, I believe that ultimately ANTM and ESRX will settle on a number to avoid a costly/long legal battle b/c it shows that ESRX is willing to pay something

• Also, ANTM accounts for 12% of ESRX’s EBITDA, so ESRX is incentivized to negotiate

There is no value being ascribed to the possibility of an ANTM/CI deal, but given the probability of the deal closing is so low, I would only account for the benefits of deal accretion in an upside case (i.e., not in a base case)

• If ANTM is allowed to buy CI, then the deal is 20%+ accretive by ’18 (per guidance)

• My calculations suggest 30%+ accretion by ‘18

• Given ANTM is undervalued, even excluding this deal accretion, there is basically no value being given to ANTM for the possibility of a deal close

• ANTM will fight the Justice Department’s antitrust lawsuit in order to close the deal, but admittedly odds of the deal closing are very slim.  I attribute no possibility for the deal closing in my base case price target

Price Target

• Current price = 130

• Base case = 180

• IRR = 27%

• Assumes P/E at 13x, and that ANTM pays the full $1.85bn breakup fee

• Downside case = 113

• IRR = -10%

• Assumes P/E at 10.0x on downside case EPS, and assumes ANTM pays the full breakup fee

• ESRX litigation in ANTM’s favor = 199

  IRR = 37%

Catalyst

• Profitability or exit of Exchanges
• ESRX litigation resolution