Description

Summary

Anthem is a well-managed and well-positioned franchise covering 44 million lives in the growing US healthcare market. The company’s dominant positions (~35% avg. local market share across its states) give Anthem significant competitive advantages and have enabled the company to drive strong results, even in a period when the company was at a disadvantage on pharmacy costs. Cost advantages, network composition, switching costs, and regulatory complexity all contribute to entrenching Anthem’s strong position. Anthem has opportunities to continue to deepen these advantages and expand its footprint by taking advantage of several growth drivers: (1) increasing penetration in managed Medicaid and Medicare Advantage, (2) better performance in Commercial Risk business due to improved pharmacy cost position as well as increasing the profitability of the ASO business, and (3) cross-selling PBM services to ASO customers plus expanding into other services over time. Anthem’s experienced management team under the strong leadership of CEO Gail Boudreaux is well-equipped to capitalize on these growth opportunities and continue to grow profitably at a faster rate than the US healthcare market. At 14x 2022 P/E, the stock is attractively priced for a company with an excellent competitive position and likely continued low to mid-teens EPS growth over the next 5 years. Apart from the potential for major structural changes to the healthcare system, the risks to Anthem’s business are quite low – and it would seem, given recent political outcomes, that the odds of a major system change in the medium-term are also quite low.

Company History

• 1946: Anthem began in Indianapolis, Indiana, as Mutual Hospital Insurance Inc. and Mutual Medical Insurance Inc. The companies grew significantly, controlling 80% of the medical insurance market in Indiana by the 1970s

• 1972: The two firms, then known as Blue Cross of Indiana and Blue Shield of Indiana, entered into a joint operating agreement

• 1985: The two firms merged

• 1993: Acquired Southeastern Mutual Insurance Company, the operator of Blue Cross and Blue Shield of Kentucky

• 1995: Acquired Community Mutual Insurance, a provider of BCBS insurance plans in Ohio

• 1997: Acquired Blue Cross and Blue Shield of Connecticut

• 1999: Acquired Blue Cross and Blue Shield of New Hampshire and Blue Cross and Blue Shield of Colorado and Nevada

• 2000: Acquired Blue Cross Blue Shield of Maine

• 2001: Anthem underwent demutualization and became a public company via an IPO which made it the 4th largest public managed care company in the United States

• 2002: Acquired Trigon Healthcare, a BCBS plan and the largest insurer in Virginia

• 2004: Wellpoint, Inc. was formed by the merger of Anthem Insurance Company and WellPoint Health Networks Inc. The merger was structured as Anthem acquiring WellPoint Health Networks and renaming itself WellPoint, Inc. WellPoint continued to use 'Anthem' as the brand name under which it operated. It sold its Blue Cross and Blue Shield products in 11 states

• 2012: Acquired Amerigroup for $4.9 billion, anticipating significant growth due to Medicaid expansion under the Patient Protection and Affordable Care Act

• 2015: Anthem offered to acquire Cigna for more than $54 billion in cash and stock

• February 2017: A United States district court ruling blocked the Cigna merger on grounds of anti-competitive practices

• October 2017: Anthem announced that it would not renew its pharmacy benefit management relationship with Express Scripts saying it had been overcharged $3 billion and that instead, Anthem would eventually handle the PBM process itself through its new IngenioRx unit. Anthem announced that it would enter a 5-year contract with CVS Health. Cigna then announced plans in March 2018 to acquire Express Scripts for $58 billion

• November 2017: Gail Boudreaux was named CEO

• 2019: IngenioRx PBM launched

Business Overview

Anthem is one of the largest diversified health benefit companies in the United States and is an independent licensee of the Blue Cross and Blue Shield Association in 14 states. The company benefits from its size, strong local market share and the brand recognition associated with BCBS. Anthem caters to all major health insurance end markets (commercial, Medicaid and Medicare). For decades, the company has been one of the most dominant players in the commercial market. Following its acquisition of Amerigroup in 2012, Anthem solidified its presence in the Medicaid market. While Anthem's market share in Medicare is relatively small, the company has demonstrated a growing focus on building out its presence and has outgrown the market in recent years. Additionally, ANTM launched its own PBM called IngenioRx in 2Q19 and completed the transition of membership in January 2020. IngenioRx has driven annual savings of ~$4bn for the company (~$900mm of which flowed through as EBIT) by transferring its fully insured business over the course of 2020.

The key to Anthem’s strategy is its strong position as the exclusive licensee of the Blue Cross Blue Shield brand in 14 states. BCBS is a highly recognizable and trusted franchise, with a legacy going back to the 1920’s. Anthem is the largest Blue Cross Blue Shield operator in the country, and the BCBS license in other states is typically held by a single-state operator. Anthem’s market share footprint is particularly strong given the company's more concentrated geographic reach compared with other competitors’ national networks. Across its license states, Anthem has achieved on average 35% market share. These high local market shares are very important in providing leverage in reimbursement negotiations with the fragmented landscape of local healthcare providers. Anthem takes advantage of its strong local market share to forge partnerships with providers, establishing value-based and risk-sharing relationships. Anthem’s use of these types of programs is well above industry averages. Today, approximately 61% of Anthem's total health care reimbursement is tied to value-based contracts, compared to 36% for the industry overall (per most recent 2019 measurement effort by HCPLAN). Additionally, Anthem benefits from its special relationship with other licensees of the BCBS Association – for example, Anthem’s national account customers are able to tap into the discounts that all the other local Blue Cross Blue Shield plans have negotiated with their providers via the Blue Card network.

Barriers to entry are very high for the health insurance industry, including cost advantages, network effects, regulatory barriers, brand, and numerous other factors. Overall, these kinds of dynamics effectively prevent new competitors because it is extremely hard to compile an attractively priced provider network without a significant membership share of that caregivers’ patient population. These factors contribute to what we perceive as a very low level of competitive risk for Anthem, barring a major healthcare system change.

Commercial (~46% of 2020 earnings)

Anthem has been a market leader in the Commercial business for many years. The company competes in both small group and large group, as well as fully-insured and ASO.  Though the company’s position in Commercial is strong, it has had somewhat muted EBIT growth over the past 10 years due to a number of factors. Management has identified some of the key factors and put in place strategies to improve performance for the Commercial business:

• Significant shift in Anthem’s membership base out of fully-insured products and into ASO

• While this has been an industry-wide trend, it has been particularly salient for Anthem

• Weak pharmacy cost position for a number of years due to Express Scripts contract

• This was a major factor in Anthem missing out on significant fully-insured business

• Under-achieved potential in adding on specialty services for ASO customers

• Penetration of vision and dental plans across customer base is ~20%, leading to a substantial gap in the EBIT-per-life between fully-insured and ASO lives. Anthem has plans to reduce this gap from a factor of 5-to-1 to closer to 3-to-1

• Weak sales execution; lack of digital tools made it hard to buy from Anthem in some cases

• Management has addressed with new sales leadership and improving IT infrastructure

Pete Haytaian was brought in as head of the Commercial business in 2018. Haytaian was previously head of Anthem’s Government business – he drove significant growth there and is known as one of the best operators in the company. A number of these efforts appear to be bearing fruit. Anthem was able to slightly grow its Commercial membership base in 2020, despite the significant increase in unemployment last year – this implies some level of market share gain for the company.

Anthem is the second-largest commercial insurer in the country, behind UNH:

Government (~35% of 2020 earnings)

From an earnings perspective, Anthem’s Government business is split roughly equally between Medicaid and Medicare. The company currently has 2.5mm Medicare lives and 9.2mm Medicaid lives (Medicare lives tend to come with a relatively higher PMPM charge and profit margin). The company also is the primary administrator for the Federal Employee Health Benefits program, covering 1.6mm lives.

Anthem has been one of the market leaders in managed Medicaid ever since it acquired AmeriGroup in 2012. AmeriGroup was one of the top-performing Medicaid-focused companies. It was successful at maintaining attractive margins while also having a strong track record in the competitive Medicaid RFP process. Anthem added these skillsets through the acquisition, and also benefitted from the ACA state Medicaid expansions that occurred beginning in 2014.

We expect that Medicaid managed care will continue to be a growing market, driven by increased coverage of high-acuity populations and the remaining Medicaid expansions (including TX and FL).

ANTM has an attractive and capital-efficient approach to operating Medicaid programs in states where it is not the BCBS licensee. The company’s recent strategy has been to partner with the local BCBS company to make a joint bid. BCBS plans traditionally do not specialize in Medicaid, so they benefit from Anthem’s stronger capabilities in this area and bring to the table their own local brands and networks. This approach has been successful in recent procurements in Minnesota and in North Carolina (the most recent major greenfield RFP – awards split roughly equally between Anthem, Centene and UNH).

Anthem is the second-largest Medicaid insurer in the country, behind Medicaid-specialist Centene:

While Anthem has consistently been one of the two largest companies in the US managed care industry over the past decade, its market position in Medicare lagged the performance of its other business lines for many years. This weakness was due to a variety of factors, including the lack of a specialized platform/product set focused on Medicare, inconsistent execution on Medicare Advantage fundamentals like sales and distribution, product design, and pricing, and weakness in Stars ratings.

However, in recent years, Anthem’s Medicare strategy has begun to coalesce, and the company has out-grown the market for several years. The company has ramped up its level of investment, improved execution, and has also acquired well-performing health plans in important geographic markets like Florida. While Anthem had a mildly disappointing outcome on its Medicare Stars performance in 2020, we believe that the in-sourcing of the PBM (and the passing on of significant savings to consumers) will improve this situation going forward. These efforts have led to significant improvements in the growth trajectory of the business, with MA lives nearly doubling from 2017-2020.

One area that company is focused increasingly going forward will be in the Group Medicare business. Because it has a significant “captive” audience in the Commercial market, Anthem should be able to cross-sell Group MA products focused on employees/retirees over 65. This is a rather obvious opportunity for the company, but one that was under-utilized for many years.

Currently, Anthem is the 4th largest provider of MA plans in the US:

IngenioRx/Other (19% of 2020 earnings)

Anthem for many years used Express Scripts as its PBM and found itself at a disadvantage on pharmacy cost as a result. Beginning in 2017, the company engineered an exit to this arrangement by signing a new and more attractively-priced contract with CVS, as well as launching its own PBM called IngenioRx. The structure of the entity places IngenioRx in charge of the capital-efficient, value-added portions of the PBM (medical management, precertification, managing formularies, etc.), while CVS handles the fulfillment services and claims processing. The fact that Anthem built its PBM entity from the ground up also enabled the company to avoid many of the conflicts of interest that have generated headlines in the PBM space over recent years. For example, Anthem’s fully-insured business has fully moved to point-of-sale rebates – this is seen as a positive move for the transparency of the industry, and a big win for patients with high out-of-pocket expenses on highly rebated drugs.

By January 1, 2020, Anthem had moved all of its fully-insured lives over to the new IngenioRx platform. Phase 1 of the new PBM strategy has focused on capturing $4bn of pharmacy savings across Anthem’s member base. Approximately $900mm went directly to the bottom line and the remainder is being returned to the customer base to improve the competitiveness of Anthem’s products (i.e. delivering $14 per member per month in savings). There was significant skepticism in the market about this initiative, but the results for 2020 have shown that Anthem has over-achieved on its goals, with the IngenioRx segment delivering healthy profits for the year. Some benefits of this strategy are only beginning to roll through – for example, Anthem’s Medicare Star ratings still reflect its old, dis-advantaged pharmacy cost position, and should improve over the next year as the IngenioRx benefits take hold.

Phase 2 of the IngenioRx strategy involves beginning to sell the company’s PBM services externally. This is seen as a harder lift than Phase 1, but there are two key areas where the company can begin to build scale. First, Anthem is making an effort to convert more of its ASO employer-plan customers to use IngenioRx. Currently, only ~20-25% of the ASO customers are working through IngenioRx for PBM services. There are benefits to aligning the PBM with the broader medical plan, and Anthem intends to make converting a larger portion of these customers over the coming years a big point of focus. Management has warned that progress on this initiative may be slow for 2021, as few employers want to risk going through a PBM transition in the midst of a pandemic. Second, Anthem will attempt to sell its PBM services to other non-Anthem BCBS plans. IngenioRx has already announced one external customer, BCBS of Idaho. Many have speculated that a partnership or merger between IngenioRx and Prime Therapeutics could build needed scale in the market and make the combined entity’s services more attractive.

Outside of the PBM, Anthem’s healthcare services are small earnings contributors today. However, the company intends to pursue other avenues of vertical integration over the coming years. One example is Anthem’s 2020 acquisition of Beacon Health Options, the country’s largest independent behavioral health organization. 

Management

Gail Boudreaux (age 60) joined Anthem as CEO in November 2017. Gail’s most important experience prior to joining Anthem was her time at UnitedHealth, where she was EVP of UnitedHealth Group from May 2008 to February 2015, President of United HealthCare from May 2008 to January 2011 and Chief Executive Officer of United HealthCare from January 2011 to November 2014. Before joining UnitedHealth, she worked at HCSC as EVP of External Operations from December 2005 to April 2008 and as President of Blue Cross Blue Shield of Illinois from July 2002 to December 2005. Before joining HCSC, Boudreaux held various positions at Aetna. She also serves as a director of the BCBSA, the National Institute for Health Care Management, Health Services Foundation, Dartmouth College Board of Trustees, and the Central Indiana Corporate Partnership, and as a member of the Business Roundtable. 

Gail’s key initiatives for the company thus far have been around implementing the PBM transition, shoring up Medicare capabilities, IT infrastructure modernization, changes to sales execution (specialty services, cross-selling), increasing partnerships with external BCBS plans, and diversifying the company into services. In conjunction with this strategy, Gail raised the stated long-term EPS growth target for Anthem from the previous 8-12% (guidance under predecessor) to 12-15%. The strategy has worked well thus far, with EPS having grown in excess of 20% for the period of 2017-2020, and the company guiding to 2021 EPS in-line with the 12-15% growth target. We believe that Gail is well-suited to drive Anthem to meet its current opportunity set; she is a strong strategic thinker, a top-notch communicator, and a respected captain and leader for the broader management team.

Some of Gail’s key lieutenants include:

• John Gallina – CFO (age 61). Gallina has been CFO of Anthem since 2016. Gallina joined Anthem in 1994 and has held a variety of leadership roles. Prior to his current role, Gallina served as Anthem’s CFO for the Commercial and Specialty Business Division from 2015 to 2016, and as SVP and Chief Accounting Officer from 2013 to 2015. Before joining the Company, Gallina spent 12 years with Coopers & Lybrand, including as an Audit Senior Manager.

• Peter Haytaian – President, Commercial (age 51). Haytaian has been the head of Anthem’s Commercial business since 2018. From 2014 until 2018, Haytaian served as President of the Government division. Haytaian joined the Company in 2012 with the acquisition of Amerigroup and served as President of the Medicaid business from 2013 until 2014. From 2005 to 2013, Haytaian held several leadership positions with Amerigroup, including serving as CEO of the North Region for Amerigroup’s Medicaid business from 2012 until 2013.

• Felicia Norwood – President, Government (age 61). Norwood has been head of Anthem’s Government business since 2018. Prior to joining Anthem, she was Director of The Department of Healthcare and Family Services for the State of Illinois from January 2015 to June 2018. Prior to that appointment, Norwood served as President of the Mid-America Region for Aetna from January 2010 until May 2013.

• Jeff Alter – EVP, IngenioRx (age 58). Alter was brought in to run IngenioRx in September 2020. Before joining Anthem, Alter served as CEO of UnitedHealthcare’s Commercial Group. Previously, he was President of Arcturus One Consulting. Alter also served as VP of Strategic Financial Planning for Oxford Health Plans; VP of Finance and Operations at Vytra Health Plans; and he also held Finance and Operations roles with Northrop Grumman and Harris Corporation.

Financials/Valuation

Anthem has achieved attractive growth over the past 5 and 10 years and significantly improved its per-share profitability. The Government business in particular has been a strong performer, benefitting from the 2012 acquisition of Amerigroup, the ACA’s boost to national Medicaid enrollment, and the continued increases in Medicare Advantage penetration. The Commercial business has been more flat over time, particularly due to member losses in the Commercial Risk portion of the market. In 2020, results have benefited from the startup of IngenioRx and the delivery of $900mm in cost savings to the bottom line:

ANTM is currently trading at 14x 2022 P/E. We believe this price is very reasonable for a company with Anthem’s profile, and several points would lead us to argue for a higher fair multiple for the stock: 

• Strong competitive positioning with dominant local market shares in an oligopolistic industry;

• Continued growth momentum for the broader healthcare market, share gains, and more managed care penetration;

• Limited regulatory risk given current state of electoral outcomes and recent Supreme Court comments;

• Limited competitive risk;

• Credible growth plan for Anthem to drive 12-15% annualized EPS growth for the long term, executed by a strong management team;

• Meaningful discount to peers such as UNH and Humana

Like the other health insurance businesses we have looked at, Anthem is a very attractive cash flow generator. The business has negative net working capital due to the significant outstanding medical claims balances that it runs with over time. Because of this, free cash flow has averaged ~110% of net income over the last number of years. Of the ~$32bn of cash flow from operations the company generated from 2015-2020, Anthem spent ~30% on share buybacks, ~20% on capex, ~20% on acquisitions, ~15% on dividends, and the remainder on other uses of capital (including changes to debt and securities balances).

Risks

• Healthcare policy risk. Though it seems Medicare-for-All is off the table, other potential policy changes, such as a Biden public option plan, could be negative for Anthem. Health insurers could play key roles in a public option and could even benefit from the expansion of services provided, if the public option merely expands access to insurance rather than causes significant shifts in insurance sources. However, if the public option creates a scenario where a significant portion of the employer-based insurance population switches to government-sponsored plans, Anthem's commercial business may suffer.

• Medical costs. Anthem has been able to manage through medical cost increases over the last 10 years, but if the next 10 years are more extreme, it could be problematic.

• COVID-19 impact. Anthem has weathered the COVID-19 period well, benefiting from decreased utilization and maintaining robust performance in its Commercial business. Some questions remain surround the level of healthcare service utilization as the US economy re-opens in 2021.

• State and local budgets. Disruption to state and local budgets can harm the funding of state Medicaid programs and could hurt Anthem’s business. A few items give us confidence that over the long term, these kinds of issues work themselves out:

• Actuarial soundness. Federal law requires that the state rate-setting processes to conform to a set of standards known as “actuarial soundness”, which require state-calculated Medicaid plan premium rates to provide for all reasonable, appropriate, and attainable costs. While there is likely some subjectivity behind actuarial soundness, it does provide a bedrock for these types of negotiations.

• CMS oversight. To push through capitation rate increases/decreases in excess of 1.5%, the state needs to go through an approval process with CMS.

• Medicare Advantage business may flounder. Though MA is an exciting growth market, it is also the subject of increased competition. Anthem has out-grown the market over the past several years, but it is not the leader in this business line and may struggle at some point.

• Services strategy. Anthem’s healthcare services platform is less developed than that of Optum and other competitors. Anthem could be left behind if these vertically-integrated models substantially transform the way that healthcare is delivered. Alternatively, Anthem could make mis-steps in M&A if it is over-eager to “catch up”.

APPENDIX

Managed Care M&A has averaged at 19x P/E and 13x EBITDA

Catalyst

- Progress on management initiatives