Description

Through owning Centene (CNC) you get exposure to secular growth in Medicaid spending and the continued trend toward outsourcing to managed Medicaid.  In addition, Centene also has exposure to Medicare Advantage which is also a growth area of health insurance as well as the ACA exchanges.  They have dominant market share in managed Medicaid and also have a long-term margin expansion opportunity over time with margins well below their closest peer, Molina.  Centene trades at an attractive valuation of 12.5x NTM P/E, which is a substantial discount to its closest peer (Molina (MOH) trades at 18.5x NTM P/E) and at the low end of its historical trading range.  We believe this opportunity exists because of concerns on covid-related risks which are misplaced.

We believe Centene could generate mid-20% returns over the next 3-4 years assuming a partial normalization of the multiple and strong long-term earnings growth.

Business Overview

Centene Corporation (CNC) is a leading multi‐national Managed Care Organization (MCO) that provides health insurance (Medicaid, Medicare, Individual) on behalf of US government sponsored and commercial healthcare programs. It is the country’s largest Medicaid managed care insurer.  CNC was founded in 1984 by a former hospital bookkeeper, and IPO’d in 2001. Since inception, CNC has completed over 100 M&A transactions totaling more than $40 billion. CNC reports two segments: Managed Care and Specialty Services:

• Managed Care (96% of 2020 sales) – Provides health plan coverage to individuals through government subsidized and commercial programs. CNC administers three different types of insurance

• Medicaid ‐ insurance for low‐income citizens, run by states with a portion of funds contributed by the Federal government

• Medicare ‐ federal insurance program for US citizens aged 65+

• Commercial plans – insurance plans on Affordable Care Act (Obamacare) healthcare Exchanges. This is for individuals who earn too much to qualify for Medicaid and are too young for Medicare. The majority of CNC members are low income and receive federal subsidies

• Specialty Services (4% of 2020 sales) – Includes diversified healthcare services to the Managed Care segment and other external customers (e.g., pharmacy benefits management)

Centene’s Medicaid business receives monthly payments (i.e., per member per month (PMPM)) from state governments in exchange for managing the state’s entire Medicaid program . In essence, the government outsources Medicaid management to MCOs like CNC. Centene assumes all medical cost risks, administers the program (e.g., determines member eligibility, communicates with members, etc), and contracts with healthcare providers (e.g., hospitals, physicians) that form the backbone of the Medicaid network. Contractually, the company is allowed to earn an actuarially sound margin, and targets a 3% ‐ 5% pretax margin range. Managed care’s value‐add is improved health outcomes at more predictable (and often lower) costs to government clients. CNC differentiates itself from other managed care providers through their (1) scale/lower cost per claim, (2) ability to invest in and provide technology capabilities, and (3) “boots on the ground” regional strategy. Over time, more and more states have embraced and expanded their managed care programs because of this value proposition

Thesis

CNC has a long runway for secular growth driven by ~MSD% Medicaid spending growth and continued outsourcing to managed Medicaid.  

Since Obamacare began in 2010, core Medicaid spending growth has been 5% annually. CMS projects total Medicaid spending to grow 5.8% annually from 2020 ‐ 2028. There is a continuing trend towards more outsourcing of Medicaid spending, which is only ~50% outsourced today. This is driven by better outcomes and state payment predictability.  Managed Care Organizations (MCO) have grown at a 14.7% CAGR through 2020 versus total Medicaid spending growth of only 5.8% due to a combination of outsourcing and Obamacare’s Medicaid expansion benefit.  Aged and disabled have both contributed to much of the outsourcing to Managed Medicaid over the last 5+ years. This suggests that states are outsourcing Long Term Services & Supports (LTSS) care (i.e., nursing home care, which often targets the aged and disabled), despite nursing facilities fighting against outsourcing Medicaid to managed Medicaid (given managed Medicaid will often lower reimbursements to nursing homes once they assume control of the state contract). Aged and disabled population groups are typically higher acuity, for which CNC receives higher reimbursements and slightly higher margins.  There is a long runway for LTSS outsourcing as only ~30% ‐ 50% of total LTSS spending is outsourced today. This penetration % increased significantly over the last 10 years. The number of states with LTSS programs has increased from 11 in 2010 to 25 today, with Oklahoma under consideration. 15 of CNC’s states currently do not have LTSS programs.

 Long term sustainable margin expansion opportunity

Incremental outsourcing of the Medicaid population is more concentrated in the higher acuity populations which command a higher % margin. Company has stated that CNC has been at 2.6-2.7% net income margins for too long and have stated a long-term goal of achieving at least 3.3% net margins by 2024. Over the last three years CNC has completed $26 billion of M&A through 11 acquisitions and has never focused on fully integrating its past acquisitions. Despite CNC’s greater scale, MOH has pretax margins that are 100bps higher than Centene.

Disrupted valuation due to misunderstandings around Covid‐related risks

The covid‐related risks include (1) reversal of healthcare stimulus (i.e., resumption of redeterminations), (2) Exchange competition due to Covid-driven unemployment, and (3) potential Covid‐related state budget pressures. We get to significant excess returns for CNC, even incorporating worst case scenarios around current market fears. In most cases,

we believe these fears are misguided:

Market Fear #1: Reversal of healthcare stimulus (i.e., remediation deferral) - During Covid, the federal government supported state spending on Medicaid under the condition they suspend redetermination and did not cut enrollment/eligibility. This support will expire at the end of FY22, after which the normal redetermination process will return and lead to member cuts. Our model assumes a full reversal of any enrollment benefit from covid which is likely conservative since a portion of the enrollment influx usually stays on.

Market Fear #2: Exchange/Marketplace competition - A more price sensitive customer during covid and increased competition in the Florida market led to temporary/local headwinds for CNC’s exchange enrollment. A large traditional insurer, who previously exited Exchanges, has announced a return in 2022. Others may follow, increasing competition and pressure CNC’s exchange margins. However, these large players do not have the low‐cost networks that CNC has built specifically for Medicaid and may not impact CNC’s market niche of highly subsidized, lower‐tier products.

Market Fear #3: Reimbursement rate risk with state budgets under pressure after covidducts - There is a narrative that, with state budgets under pressure, states may try to lower Medicaid rates with the insurers. We believe this is incorrect because (1) State budgets ended up being fine, (2) Medicaid reimbursements and spending continued to grow during the Great Financial Crisis, suggesting very little correlation between Medicaid reimbursement and state budget growth, (3) CNC proactively approached states during Covid to give money back and share gains from abnormally low utilization, giving states less incentive to try to cut Medicaid budgets, (4) contractually, CNC must earn a margin that is actuarially sound, and margins are already in the range of what is widely accepted as a “fair” Medicaid margin.

CNC is a possible acquisition target

CNC’s CEO since 2004, Michael Neidroff, is 78 years old and is without a clear successor. Centene announced its acquisition of WellCare ($17.3bn) on 3/27/19. Corvex and Sachem Head (activists) took positions in Centene in May ’19, intending to block Centene’s WellCare acquisition and, instead, force a sale of the company to Humana. Humana (on 6/3/19) stated that it will not buy Centene, with reports stating that Humana did not want Centene’s Exchange/Marketplace exposure. Humana had exited Exchanges for the last few years prior to ‘19 (Humana stated it would pull out of the Exchanges in Feb ‘17). However, now more insurers are warming up to the idea of returning to the Exchanges, given their continued profit margin stability. At the time, the other potential acquirer with gaps in their Medicaid product offering was Cigna. However, Cigna had just closed their acquisition of Express Scripts and was focused on debt paydown. They have made significant progress since, and could be in a position to be

acquisitive again soon.

Catalyst

Continued improvement in margin towards long-term targets

Re-initiating redetermination and having more of the business stay on

Continued strong top line growth