General Business Issues

Featured HBD Story January 4, 2008

Health Plans, Financial Analysts See 2008 M&A Deals That Are Smaller and Targeted to Certain Markets, Specialties

Reprinted from HEALTH PLAN WEEK (formerly Managed Care Week), the industry's leading source of business, financial and regulatory news of health plans, PPOs and POS plans.

2008 likely won't bring any blockbuster acquisitions of one giant health insurer by another, but the volume of regional plan acquisitions is expected to continue, predict financial analysts, investment bankers and the insurers themselves. Health plans will continue to seek deals to fill in holes in geographic areas, service lines or other capabilities. And some Medicare plans may put themselves up for sale if the results of the ongoing open-enrollment season are disappointing.

Most acquisitions proposed or completed by health insurers in 2007 were of local or regional plans or vendors. Jonathan Korngold, a managing director at global private-equity firm General Atlantic LLC, says that trend will continue into 2008. "Payers will seek to fill out either regional provider network holes that they have today, or try to supplement individual product lines that they may be underinvested in," he predicts.

Korngold points to UnitedHealth Group's pending acquisition of Sierra Health Services, Inc. to fill out its Nevada network, and Aetna, Inc.'s August 2007 purchase of Schaller Anderson, Inc. to strengthen Medicaid capabilities.

In 2008, CIGNA Corp. has said, it may make acquisitions to support its strategy of entering the individual and very-small-group markets. Similarly, Coventry Health Care, Inc. told investors Dec. 5 that it plans to make acquisitions to support its specialty market entrance.

Aetna, Inc. CFO Joseph Zubretsky also conceded that "there still is a need to grow by acquisition to create local market density in certain markets." Speaking at the Merrill Lynch Health Services Investor Conference in New York in late November, he added that the need is not urgent since "we are able to negotiate fairly good discounts in some of these markets where we don't yet have critical mass."

The slow pace of enrollment growth in the commercial market — and declining operating margins in that segment — also are driving insurers to consolidate, says Shellie Stoddard, a director in the financial services ratings unit of Standard & Poor's.

The Medicare Advantage (MA) industry already has seen some consolidation, and consulting firm Gorman Health Group, LLC expects that trend to intensify in 2008, says spokesperson Carol Sardinha. "If some plans don't make their numbers or don't get any organic growth" for 2008 via the ongoing open-enrollment period, they may choose to tell CMS that they will not renew their contract for 2009, she predicts. "We'll probably see several plans not renewing."

That represents an acquisition opportunity for midsized and large MA plans, since organic membership growth has become very difficult, Sardinha explains. "There are only so many more individuals [entering the program each year]."

"Probably, some of the early consolidation activity will occur among Special Needs Plans," Sardinha says, adding that 57% of SNPs have fewer than 500 members. "That is absolutely unsustainable — and it's particularly true for lot of [Medicare/Medicaid] dual-eligible plans. They're going to really have to contract."

Acquirers May Have Fewer Rivals in '08

"2008 might be, on balance, a better year for strategic acquirers than 2007," Korngold says. In recent years, health care industry buyers making acquisitions for strategic reasons have found themselves in bidding wars with investment groups. In 2006 and 2007, financial buyers had access to incredibly generous amounts of leverage, resulting in unprecedented capital structures being applied to health care transactions, he explains. But in 2008, Korngold says, private-equity firms likely will find their access to leverage more constrained.

Still, valuations certainly won't plummet, says Brian Wright, an equity analyst at Jefferies & Co., Inc. "You're still going to have the competition amongst the strategic buyers."

What's more, some health insurers themselves have become willing to take on greater levels of debt, Stoddard says. In its "2008 U.S. Managed Care Insurer Outlook," S&P cites as one example UnitedHealth Group, which recently said it may increase its debt-to-total capital ratio to 40%. The insurer had kept the ratio at 25% to 30%.

Blockbuster deals between two national or super-regional health insurers are less likely because of antitrust concerns, says Brad Ellis, a director at Fitch Ratings' insurance group. "It's growing more difficult" because of barriers like size and market share."

Health Net, Inc. is one insurer that often is named as a potential acquisition target. But with health plans on both coasts, it would be difficult to find a buyer that has low enough enrollment on both coasts to avoid triggering regulatory action, Ellis says.

For its part, Health Net says an acquisition isn't imminent. Speaking at the Merrill Lynch health care conference in November, CEO Jay Gellert conceded that "whenever anyone talks about consolidation, they basically say we fit with everyone." But, he added, "we have a clear [strategic] path, so we don't need to do a deal. That makes it so that somebody [would].have to really badly want to do a deal, and I'm not sure there's that level of appetite at this point and time in the industry."

Still, Ellis says that a slowdown in very large acquisitions could be "a good thing.…A lot of stuff has to be digested, and a lot of platforms out there have to be migrated together," he says. "For efficiency's sake, it might be a good thing to take a couple of years' pause."

Of course, he adds, a big deal could suddenly pop up. "A couple of companies have their books out," he says, although he declines to identify specific insurers. "Anything's for sale at the right price."

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