How about a long-idea with positive industry trends in
2009? Amerigroup is an opportunity to invest
in the leading Medicaid managed care company with significant long-term and
short-term tailwinds at a very attractive price.
INDUSTRY BACKGROUND: MEDICAID MANAGED CARE
Medicaid managed care saves states money now and in
the future:
Medicaid is the state-run
healthcare system in the U.S.
for the poor and disabled which represents approximately 16% of national health
spending ($380 billion expected in FY09). Medicaid programs are administered on a state-by-state basis under broad
Federal guidelines, and are funded by state governments with a federal match,
which ranges from 1:1 to 3:1 (depending on the wealth of the state’s
residents). Medicaid managed care plans
get paid on a monthly basis (“per member, per month”, or “PMPM”) and are then
responsible for managing the health of those members. Details vary by state and by program, and complexity
rules the day, which creates barriers to entry.
Managed care has become an
increasingly acceptable method for bringing health benefits to the poorest
members of the community. Over the past
20 years, states have been experimenting with managed care programs for various
Medicaid populations (such as pregnant women, people with disabilities,
children in foster care, etc.), and third-party studies have verified managed
care’s ability to save states money. (See appendix B-1 of http://www.ahipresearch.com/pdfs/MedicaidCostSavings.pdf) Savings come from proactive approaches to
preventative care and tightly managed networks to limit overutilization. For example, a managed care company might help
a poor pregnant women to stay healthy during a pregnancy, reducing potentially
higher costs later on from an unhealthy baby.
Across the country,
approximately 65% of the Medicaid eligible population is enrolled in managed
care plans, and in anticipation of tough budget times, states are increasing
their managed care initiatives. The
Kaiser Family Foundation reports that in FY2009, 18 states are going to
increase their managed care service areas or expand populations. In addition, Obama’s stimulus plan will
undoubtedly include (a) expansion of Medicaid eligibility, (b) expansion of
SCHIP (a children’s health insurance program for children who don’t qualify for
Medicaid), and/or (c) increases in the federal match (potentially up to $40
billion), which will help solve states’ funding issues. This
represents the near-term opportunity for Amerigroup and the industry. Keep in mind that existing Medicaid programs
are one of the fastest ways for the federal government to get money to the
states.
While 65% of the
Medicaid-eligible population is enrolled in managed care, only about 15% of the
costs are associated with managed care plans. This is because states have been more aggressive in moving the healthier
populations like adults and children to managed care while continuing to treat
the aged, blind, and disabled population (ABD) on a fee-for-service (or
unmanaged) basis. The ABD population
accounts for ~24% of all Medicaid enrollees but 70% of the costs, largely
because of long-term care needs (which Medicare does not pay for). The
medium and long-term opportunity for Amerigroup and its competitors lies here
in slowing the long-term care expenses for an aging society.
Medicaid managed care is
highly fragmented, with the top 10 companies representing less than 40% of the
enrolled lives. Much of the competition
is from community-based non-profits, which have an obvious cost advantage, but
my sources tell me that Medicaid directors like having for-profits in the
program due to their creative approaches and efficient operations. One former Medicaid director told me that
it’s the for-profits that “keep the not-for-profits honest.”
INVESTMENT THESIS
Enrollment as % of AGP Total
Party: Governor/ Lower/ Upper
House
Expected program expansion in 2009
State Mgd Care % as of 6/30/06
Medicaid Budget (FY06) $B
Relations since
Texas
27%
R/R/R
69%
$18.1
1996
Tennessee
21%
D/D/R
100%
$6.1
2007
Georgia
12%
R/R/R
98%
$6.8
2006
Florida
13%
R/R/R
x
66%
$12.8
2003
Maryland
9%
D/D/D
x
70%
$5.0
1999
New York
6%
D/D/D
x
61%
$44.7
2005
New Jersey
6%
D/D/D
x
69%
$9.1
1996
Ohio
3%
D/R/R
40%
$12.3
2005
Virginia
1%
D/R/D
63%
$4.7
2005
South Carolina
1%
R/R/R
20%
$4.1
2007
New Mexico
0%
D/D/D
x
65%
$2.5
2008
Amerigroup can grow the top
line in three ways:
(a)
Increased eligibility in the short-term: As unemployment rises, Medicaid enrollment
will rise as well. In the last downturn
from 2001-2003, Medicaid enrollment increased 7.9%, 9.5%, and 5.6% in those
three years. Amerigroup doesn’t need to
do any incremental work to capture these members due to the fact that in many
states, individuals are assigned to the managed care organization: they will
get their pro-rata share of the increase without much additional work.
(b)
Continued increase in managed care
penetration within existing states in the medium-term: In 2009, five of Amerigroup’s 11 state
clients are expanding their managed care programs with Amerigroup. On a weighted-average basis, the managed care
penetration in Amerigrioup’s states is only 64%, so there is additional room to
grow.
(c)
Addition of new programs in new states,
especially long-term care in the long-term (no pun intended): Since 2005, Amerigroup has entered seven new
states, and they expect to enter Nevada
in 2009. In 2008, they began a new
initiative with New Mexico
(a new state) for an innovative long-term care program, which is largely
designed to keep the elderly poor out of nursing homes by helping them manage
their health and healthcare in the home setting.
Long-term
care represents the largest opportunity for Amerigroup, since approximately 25%
of all Medicaid spending is for long-term care, and 75% of that is for nursing
homes. Given the demographic tidal wave
of elderly, states need to get ahead of this problem or they will become
insolvent (unlike the Feds, most states require balanced budgets each
year). However, currently less than 3%
of the elderly eligible for Medicaid are enrolled in managed care plans. States are increasingly open to working with
managed care plans to help their states save money and predict their
budgets. Managed long-term care can
result in a win-win-win scenario: the state has lower and more predictable
costs; the managed care company can make a profit, and the beneficiary can stay
in their home longer than otherwise possible.
While net margins are just
between 2-3%, Amerigroup has
opportunities to improve its bottom line by expanding scalable processes and
procedures. Given the difficult life
circumstances of most Medicaid beneficiaries, this is a challenging population
to serve, and Amerigroup has figured out the best ways to manage poor and
disabled populations in a way that locally-based not-for-profits will not be
able to. In addition, Amerigroup can
leverage its member call center, claims processing system, and network
contracting team across a broader number of states and members than other
companies, especially the not-for-profits.
Outstanding performance:
Amerigroup’s ability to
manage costs within these populations can be seen in their Medical Loss Ratio
(MLR) (the term for COGS within health insurance) for their established and
steady-state programs vs. their start-up programs. In expansion markets, their MLR is around
88-89% while their “core” markets have an MLR of 79-81%. This performance is what is most attractive
to states that want to control healthcare costs. This is simply the natural result of having
someone pay attention to medical costs – states simply pay claims.
Part of this performance is a
result of Amerigroup’s sole focus on Medicaid, which allows it to negotiate
more favorable terms with providers in its networks. Multi-line health insurers (like United or
Wellpoint) have a more difficult time negotiating lower rates than Amerigroup
since Medicaid reimbursement is almost always lower than commercial or Medicare
reimbursement, even when a managed care company is involved. As a result, Amerigroup enjoys a 400-500 basis point MLR advantage vs. the
multi-line health insurers.
Attractive returns on capital:
I contend that this is a good
company in a good space, but is this a good business? Let me illustrate with a hypothetical example
of how the business works. Let’s say
Amerigroup signs up for a new program within a state, representing 10,000
members and a premium of $150 per member-per month. The state would require Amerigroup to put
some capital upfront to ensure that it would be able to handle claims from the
start. This ranges from 4-6% of annual
premiums, or $720k to $1.08 million. Amerigrioup targets 2.5-3.5% net income margins, because it is unlikely
that they will be able to “get away” with more than that given the political
nature of Medicaid managed care. Nonetheless, the normalized returns on capital can range from 25% to 50%
(see table)
Illustrative Incremental Returns on Capital
Net income margins
Upfront
capital requirement
1%
2%
3%
4%
25%
50%
75%
5%
20%
40%
60%
6%
17%
33%
50%
This is a simplistic
illustration, and obviously there will be some set-up costs associated with
getting the new program off the ground, but for an established company like
Amerigroup, there are fewer set-up costs relative to others, and their
experience gives them the ability to hit the higher net income margins faster
than others. On the positive side, a
cash-based view of returns would be even more attractive since managed care
plans are paid well in advance of their claims. In many cases, these programs can become self-financing in about 3-6
months.
Attractive valuation and solid balance sheet:
Despite the positive trends, Amerigroup
is trading at 11 P/E (2009) and 3.8x EV/EBITDA (for purposes of EV, I take a
conservative approach by treating the “claims payable” as debt, since they have
already collected the cash and are responsible for paying those claims). In addition, they have decent short-term
visibility in 2009, since the reimbursement rates on 65% of their member-months
have already been set – at a weighted-average rate increase of 4.7%.
I believe that with modest
enrollment growth of 5% for the next couple of years and modest rate increases
of 4%, Amerigroup can grow its bottom line by over 15% per year for the next
few years, before stock buybacks. In
addition, over the next few years, interest rates are likely to rise (even
slightly) and as such we should see additional earnings growth.
Amerigroup has a conservative
balance sheet. They have has $1.35
billion in cash and investments, of which $280m is unrestricted at the parent
level – and only $310m of debt. Through
Sept 30, they generated $170m of adjusted cash from operations, and they
repurchased $4m of stock in Q3. Their
portfolio consists of 52% money-market; 38% government-sponsored entities; 4%
investment-grade corporate bonds; and 6% municipal student loan corporation
auction-rate securities. The average
duration is 8-9 months. As a result,
their investment income will be tiny in 2009, but they will not have the
write-offs that some other managed care companies have and will have.
In addition, last week
Amerigroup modified its senior credit agreement to allow for increased stock
repurchases, convertible debt repurchases, and larger acquisitions.
RISKS:
-
Headline risk: Governors will make a lot of headlines (especially
early in 2009) about how bad the fiscal conditions are in their states. However, if the federal government bails out
Citi, they will bail out the states too. There is a concern that some of the states
will cut across the board given the nature of their budget problems, but a 2002
law requires Medicaid managed care rates to be “actuarially sound”, and states
know that plans will withdraw from states if rates are not economically viable.
- Group risk: At times, Amerigroup trades with the rest of
the managed care space, even if there are issues that have nothing to do with Amerigroup. Sometimes it trades in sympathy with other
Medicaid managed care companies, even if their issues are in states where Amerigroup
doesn’t operate. Group balance sheet
concerns have also impacted the stock, despite the fact that Amerigroup has the
most conservative balance sheet of them all.
-
Execution risk: Amerigroup has to manage health expenses well
because with slim margins, it doesn’t have a lot of room for error.-
- Compliance risk: Medicaid managed care companies
are scrutinized heavily by the states and have sometimes run into trouble. This happened to Amerigroup under previous
management in 2002 in Illinois and Wellcare
last year in Florida.
- Kucinich risk: Some people are under the impression that Democrats will
move to a nationalized healthcare system, controlled by the government
(proposed by Dennis Kucinich, Democratic Representative from Cleveland). I think there is as likely a chance of this happening as Kucinich’s standing
in the New Hampshire
Democratic primary: 1.4%.
Catalyst
• Obama stimulus package in early 2009.
• Additional state expansion of Medicaid managed care programs.
• Announcement of larger stock buyback or open-market convertible debt repurchases.
sort by
Description
How about a long-idea with positive industry trends in
2009? Amerigroup is an opportunity to invest
in the leading Medicaid managed care company with significant long-term and
short-term tailwinds at a very attractive price.
INDUSTRY BACKGROUND: MEDICAID MANAGED CARE
Medicaid managed care saves states money now and in
the future:
Medicaid is the state-run
healthcare system in the U.S.
for the poor and disabled which represents approximately 16% of national health
spending ($380 billion expected in FY09). Medicaid programs are administered on a state-by-state basis under broad
Federal guidelines, and are funded by state governments with a federal match,
which ranges from 1:1 to 3:1 (depending on the wealth of the state’s
residents). Medicaid managed care plans
get paid on a monthly basis (“per member, per month”, or “PMPM”) and are then
responsible for managing the health of those members. Details vary by state and by program, and complexity
rules the day, which creates barriers to entry.
Managed care has become an
increasingly acceptable method for bringing health benefits to the poorest
members of the community. Over the past
20 years, states have been experimenting with managed care programs for various
Medicaid populations (such as pregnant women, people with disabilities,
children in foster care, etc.), and third-party studies have verified managed
care’s ability to save states money. (See appendix B-1 of http://www.ahipresearch.com/pdfs/MedicaidCostSavings.pdf) Savings come from proactive approaches to
preventative care and tightly managed networks to limit overutilization. For example, a managed care company might help
a poor pregnant women to stay healthy during a pregnancy, reducing potentially
higher costs later on from an unhealthy baby.
Across the country,
approximately 65% of the Medicaid eligible population is enrolled in managed
care plans, and in anticipation of tough budget times, states are increasing
their managed care initiatives. The
Kaiser Family Foundation reports that in FY2009, 18 states are going to
increase their managed care service areas or expand populations. In addition, Obama’s stimulus plan will
undoubtedly include (a) expansion of Medicaid eligibility, (b) expansion of
SCHIP (a children’s health insurance program for children who don’t qualify for
Medicaid), and/or (c) increases in the federal match (potentially up to $40
billion), which will help solve states’ funding issues. This
represents the near-term opportunity for Amerigroup and the industry. Keep in mind that existing Medicaid programs
are one of the fastest ways for the federal government to get money to the
states.
While 65% of the
Medicaid-eligible population is enrolled in managed care, only about 15% of the
costs are associated with managed care plans. This is because states have been more aggressive in moving the healthier
populations like adults and children to managed care while continuing to treat
the aged, blind, and disabled population (ABD) on a fee-for-service (or
unmanaged) basis. The ABD population
accounts for ~24% of all Medicaid enrollees but 70% of the costs, largely
because of long-term care needs (which Medicare does not pay for). The
medium and long-term opportunity for Amerigroup and its competitors lies here
in slowing the long-term care expenses for an aging society.
Medicaid managed care is
highly fragmented, with the top 10 companies representing less than 40% of the
enrolled lives. Much of the competition
is from community-based non-profits, which have an obvious cost advantage, but
my sources tell me that Medicaid directors like having for-profits in the
program due to their creative approaches and efficient operations. One former Medicaid director told me that
it’s the for-profits that “keep the not-for-profits honest.”
INVESTMENT THESIS
Enrollment as % of AGP Total
Party: Governor/ Lower/ Upper
House
Expected program expansion in 2009
State Mgd Care % as of 6/30/06
Medicaid Budget (FY06) $B
Relations since
Texas
27%
R/R/R
69%
$18.1
1996
Tennessee
21%
D/D/R
100%
$6.1
2007
Georgia
12%
R/R/R
98%
$6.8
2006
Florida
13%
R/R/R
x
66%
$12.8
2003
Maryland
9%
D/D/D
x
70%
$5.0
1999
New York
6%
D/D/D
x
61%
$44.7
2005
New Jersey
6%
D/D/D
x
69%
$9.1
1996
Ohio
3%
D/R/R
40%
$12.3
2005
Virginia
1%
D/R/D
63%
$4.7
2005
South Carolina
1%
R/R/R
20%
$4.1
2007
New Mexico
0%
D/D/D
x
65%
$2.5
2008
Amerigroup can grow the top
line in three ways:
(a)
Increased eligibility in the short-term: As unemployment rises, Medicaid enrollment
will rise as well. In the last downturn
from 2001-2003, Medicaid enrollment increased 7.9%, 9.5%, and 5.6% in those
three years. Amerigroup doesn’t need to
do any incremental work to capture these members due to the fact that in many
states, individuals are assigned to the managed care organization: they will
get their pro-rata share of the increase without much additional work.
(b)
Continued increase in managed care
penetration within existing states in the medium-term: In 2009, five of Amerigroup’s 11 state
clients are expanding their managed care programs with Amerigroup. On a weighted-average basis, the managed care
penetration in Amerigrioup’s states is only 64%, so there is additional room to
grow.
(c)
Addition of new programs in new states,
especially long-term care in the long-term (no pun intended): Since 2005, Amerigroup has entered seven new
states, and they expect to enter Nevada
in 2009. In 2008, they began a new
initiative with New Mexico
(a new state) for an innovative long-term care program, which is largely
designed to keep the elderly poor out of nursing homes by helping them manage
their health and healthcare in the home setting.
Long-term
care represents the largest opportunity for Amerigroup, since approximately 25%
of all Medicaid spending is for long-term care, and 75% of that is for nursing
homes. Given the demographic tidal wave
of elderly, states need to get ahead of this problem or they will become
insolvent (unlike the Feds, most states require balanced budgets each
year). However, currently less than 3%
of the elderly eligible for Medicaid are enrolled in managed care plans. States are increasingly open to working with
managed care plans to help their states save money and predict their
budgets. Managed long-term care can
result in a win-win-win scenario: the state has lower and more predictable
costs; the managed care company can make a profit, and the beneficiary can stay
in their home longer than otherwise possible.
While net margins are just
between 2-3%, Amerigroup has
opportunities to improve its bottom line by expanding scalable processes and
procedures. Given the difficult life
circumstances of most Medicaid beneficiaries, this is a challenging population
to serve, and Amerigroup has figured out the best ways to manage poor and
disabled populations in a way that locally-based not-for-profits will not be
able to. In addition, Amerigroup can
leverage its member call center, claims processing system, and network
contracting team across a broader number of states and members than other
companies, especially the not-for-profits.
Outstanding performance:
Amerigroup’s ability to
manage costs within these populations can be seen in their Medical Loss Ratio
(MLR) (the term for COGS within health insurance) for their established and
steady-state programs vs. their start-up programs. In expansion markets, their MLR is around
88-89% while their “core” markets have an MLR of 79-81%. This performance is what is most attractive
to states that want to control healthcare costs. This is simply the natural result of having
someone pay attention to medical costs – states simply pay claims.
Part of this performance is a
result of Amerigroup’s sole focus on Medicaid, which allows it to negotiate
more favorable terms with providers in its networks. Multi-line health insurers (like United or
Wellpoint) have a more difficult time negotiating lower rates than Amerigroup
since Medicaid reimbursement is almost always lower than commercial or Medicare
reimbursement, even when a managed care company is involved. As a result, Amerigroup enjoys a 400-500 basis point MLR advantage vs. the
multi-line health insurers.
Attractive returns on capital:
I contend that this is a good
company in a good space, but is this a good business? Let me illustrate with a hypothetical example
of how the business works. Let’s say
Amerigroup signs up for a new program within a state, representing 10,000
members and a premium of $150 per member-per month. The state would require Amerigroup to put
some capital upfront to ensure that it would be able to handle claims from the
start. This ranges from 4-6% of annual
premiums, or $720k to $1.08 million. Amerigrioup targets 2.5-3.5% net income margins, because it is unlikely
that they will be able to “get away” with more than that given the political
nature of Medicaid managed care. Nonetheless, the normalized returns on capital can range from 25% to 50%
(see table)
Illustrative Incremental Returns on Capital
Net income margins
Upfront
capital requirement
1%
2%
3%
4%
25%
50%
75%
5%
20%
40%
60%
6%
17%
33%
50%
This is a simplistic
illustration, and obviously there will be some set-up costs associated with
getting the new program off the ground, but for an established company like
Amerigroup, there are fewer set-up costs relative to others, and their
experience gives them the ability to hit the higher net income margins faster
than others. On the positive side, a
cash-based view of returns would be even more attractive since managed care
plans are paid well in advance of their claims. In many cases, these programs can become self-financing in about 3-6
months.
Attractive valuation and solid balance sheet:
Despite the positive trends, Amerigroup
is trading at 11 P/E (2009) and 3.8x EV/EBITDA (for purposes of EV, I take a
conservative approach by treating the “claims payable” as debt, since they have
already collected the cash and are responsible for paying those claims). In addition, they have decent short-term
visibility in 2009, since the reimbursement rates on 65% of their member-months
have already been set – at a weighted-average rate increase of 4.7%.
I believe that with modest
enrollment growth of 5% for the next couple of years and modest rate increases
of 4%, Amerigroup can grow its bottom line by over 15% per year for the next
few years, before stock buybacks. In
addition, over the next few years, interest rates are likely to rise (even
slightly) and as such we should see additional earnings growth.
Amerigroup has a conservative
balance sheet. They have has $1.35
billion in cash and investments, of which $280m is unrestricted at the parent
level – and only $310m of debt. Through
Sept 30, they generated $170m of adjusted cash from operations, and they
repurchased $4m of stock in Q3. Their
portfolio consists of 52% money-market; 38% government-sponsored entities; 4%
investment-grade corporate bonds; and 6% municipal student loan corporation
auction-rate securities. The average
duration is 8-9 months. As a result,
their investment income will be tiny in 2009, but they will not have the
write-offs that some other managed care companies have and will have.
In addition, last week
Amerigroup modified its senior credit agreement to allow for increased stock
repurchases, convertible debt repurchases, and larger acquisitions.
RISKS:
-
Headline risk: Governors will make a lot of headlines (especially
early in 2009) about how bad the fiscal conditions are in their states. However, if the federal government bails out
Citi, they will bail out the states too. There is a concern that some of the states
will cut across the board given the nature of their budget problems, but a 2002
law requires Medicaid managed care rates to be “actuarially sound”, and states
know that plans will withdraw from states if rates are not economically viable.
- Group risk: At times, Amerigroup trades with the rest of
the managed care space, even if there are issues that have nothing to do with Amerigroup. Sometimes it trades in sympathy with other
Medicaid managed care companies, even if their issues are in states where Amerigroup
doesn’t operate. Group balance sheet
concerns have also impacted the stock, despite the fact that Amerigroup has the
most conservative balance sheet of them all.
-
Execution risk: Amerigroup has to manage health expenses well
because with slim margins, it doesn’t have a lot of room for error.-
- Compliance risk: Medicaid managed care companies
are scrutinized heavily by the states and have sometimes run into trouble. This happened to Amerigroup under previous
management in 2002 in Illinois and Wellcare
last year in Florida.
- Kucinich risk: Some people are under the impression that Democrats will
move to a nationalized healthcare system, controlled by the government
(proposed by Dennis Kucinich, Democratic Representative from Cleveland). I think there is as likely a chance of this happening as Kucinich’s standing
in the New Hampshire
Democratic primary: 1.4%.
Catalyst
• Obama stimulus package in early 2009.
• Additional state expansion of Medicaid managed care programs.
• Announcement of larger stock buyback or open-market convertible debt repurchases.
Are you sure you want to close this position Amerigroup?
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