Having scarcely emerged from its own financial ashes, Coventry Corp., a Nashville-based operator of HMOs, has agreed to buy Principal Health Care, the managed-care subsidiary of Des Moines, Iowa-based Principal Financial Group, for about $375 million in stock.
Coventry said it will merge operations with Principal's HMO unit, forming a new company to be called Coventry Health Care and based in Bethesda, Md.
Under the transaction, which is expected to close in the first quarter of 1998, Principal would retain a 40% stake in the new firm.
In addition, Coventry would manage Principal Mutual's health insurance indemnity business for an annual fee of 3.3% of premiums through December 1999.
Based on forecasts of the two merging companies, Coventry Health Care would have annual revenues of $2.4 billion and 1.3 million at-risk lives-compared with Coventry's current 753,000 at-risk lives.
Coventry's purchase reflects the company's newfound strength after a rapid turnaround in its flagging HMO business. For the nine months ended Sept. 30, Coventry reported net income of $8.4 million, compared with a $9.1 million net loss in the year-ago period.
Coventry management said the company's financial progress allowed it to seize "an exceptional market opportunity" by acquiring Principal now through a stock swap.
"We initially focused our resources on improving Coventry's internal operations," said Allen F. Wise, who became Coventry's chairman and chief executive officer in 1996. "Our recognized success thus far has allowed us to . . . examine external opportunities."
Except for in the St. Louis area, there is little overlap among the two companies' businesses. And analysts expect Coventry to prune some of Principal's lesser markets through sale or swap with other HMOs.
"Principal's book of business isn't that strong," said Todd Richter, an analyst with Morgan Stanley Dean Witter, New York. "The issue for Coventry will be which markets to keep and which to get rid of."
After the purchase Coventry will serve 21 markets, with Principal's additions coming mostly in second-tier cities and rural markets.
A dozen of Principal's HMO plans have fewer than 35,000 enrollees. Therefore, Coventry's first order of business, according to Thomas Hodapp, an analyst with BancAmerica Robertson Stephens, will be to exit those markets that are losing money and have little strategic value.
Financial information for privately held Principal is scarce. Its HMO business line lost about $50 million last year, according to James Lane, an analyst with SBC Warburg Dillon Read, New York, although it has lately been moving toward profitability.
Lane is optimistic Coventry can repeat its turnaround magic on Principal's healthcare business.
"Allen Wise knows how to run an HMO as well as anyone in the country," Lane said.