Anthem ATH
January 18, 2002 - 5:34pm EST by
2002 2003
Price: 51.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 5,255 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Anthem Inc is a Blue Cross Blue Shield HMO. The company went public in a demutualization in 10/01 and the stock is up from $36 to $51 in a few months. The company serves 8 million members in eight states Indiana, Kentucky, Ohio (Midwest), Connecticut, New Hampshire, Maine (Northeast) and Colorado & Nevada (West). They are closing on Kansas BCBS in summer 2002.

Anthem trades at 14x 2002 earnings while the comparables Trigon Healthcare (TGH) trades for 15x and Wellpoint trades for 18x. If Anthem trades at a level in line with the comparables, it is worth 16x $3.65 of 2002 earnings, or $58 per share -- up over twenty percent from here.

More importantly Anthem has much lower operating margins than the comparables (marginally under 4% at Anthem versus 5% for Wellpoint and Trigon.) Until now Anthem was a mutual insurer with no incentive to increase operating efficiencies. If ATH can increase margins to 5%, the company will have earnings of more than $4.50 per share. A 16x multiple results in a $70+ stock price.

The stock has been a bit volatile lately. I think a lot of the big funds have built up core positions and there's some shareholders (policyholders and flippers from the IPO) who are putting some pressure on the stock. Once selling pressure subsides, and the company delivers on earnings, the stock should do very well.

There is of course some risk to the stock.

1) Execution risk - management must be able to properly price their book of business. If they get pricing wrong (by not estimating the medical costs properly), they end up paying out more in claims than they collect. While the business re-prices every year, if there is a persistent problem in improperly setting premiums, the company will trade at a discount to the group. Pricing in managed care is up 12% in Q3, and HMOs continue to push price to meet increasing medical costs. Medical loss ration (MLR) is the amount of premiums paid out in medical losses. In Q3 2001, Anthem had a 85% MLR versus 81% for Trigon and 82% for Wellpoint.

2) Turnaround risk – ATH has done a number of acquisitions in the past and has to deal with systems intregration. Anthem acquired Kentucky in 1993, Ohio in 1995, Connecticut in 1997, New Hampshire and Colorado and Nevada in 1999 and Maine in 2000. In 2002 they will close on Kansas. This acquisition history makes the underlying fundamentals difficult to discern.

3) Acquisition risk – ATH is in process of putting together a national blue cross blue shield network. Anthem and Wellpoint are competing to put together a national Blue Cross Blue Shield program and there could be risk of high priced acquisitions. (Wellpoint is in process of buying Rightchoise (RIT) the BCBS of Missouri for over 20x earnings.)

4) Economic risk - HMO management has to be able to increase margins in a relatively weak economy. A weak economy puts pressure on enrollment growth and premium rates. This economic pressure affects the entire group.

5) Litigation risk - there is some litigation in certain markets against HMOs. The country has bigger fish to fry than the HMOs right now, and the well-recognized Blue Cross providers are benefitting from the social pressure on more traditional HMOs.


2-3 multiple point discount to group, plus there is margin expansion.
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