Aetna's proposed $37 billion offer for Humana is about building strength and scale in the government insurance business, but some investors are nervous about whether the parties can deliver on expectations.
Shares of the Hartford, Conn.-based insurer opened more than 6% lower Monday than their closing price on July 2 and continued to fall in the early afternoon.
The drop represents concerns about Humana's future earnings after the company said in a regulatory filing that it now expects earnings per share to be lower than previously forecast.
Humana is projecting earnings per share of $7.75 compared with earlier guidance of $8.50 to $9 per share. The Louisville, Ky.-based managed-care company saw higher-than-expected medical costs in the second quarter, including a higher number of Medicare Advantage admissions per 1,000 members.
“The risk is around the earnings outlook for Humana,” said David Windley, an analyst at Jefferies.
While Humana said it was able to account for those higher costs in next year's Medicare Advantage bids—which would allow it to maintain a pre-tax margin of 4.5% to 5%—questions still remain about whether it can achieve that growth. “You never really know until it plays out,” Windley said.
Aetna, for its part, said it became aware of Humana's revised earnings expectations during due diligence and is comfortable with its risk-adjustment models.
Still, what's clear is that insurers see the government insurance business as a key growth driver. About 30% of Medicare beneficiaries are choosing a Medicare Advantage plan, and uptake is expected to grow more than 4% annually over the next 10 years, said Frank Morgan, an analyst at RBC Capital Markets.
And while the plans have experienced rate cuts, reimbursement is expected to stabilize over the next few years, offering “respectable, predictable margins in the 3% to 5% range for the foreseeable future,” he wrote in a research note.
“The attractiveness of Medicare Advantage is that we're in a period where baby boomers are aging into Medicare,” Windley said. “The growth of new members is pretty attractive.”
Aetna will have 56% of its business coming from Medicare, Medicaid and Tricare as a result of the transaction, CEO Mark Bertolini said on an investor call Monday.
“The combination will increase Aetna's exposure to fast-growing government programs,” he said, adding that the tie-up brings together two of the fastest-growing Medicare Advantage plans.
The combined company is expected to generate $115 billion in revenue and have 14.2 million members, including 4.4 million in a Medicare Advantage plan.
The growth opportunity for the Medicare Advantage business was one reason A.J. Rice, an analyst at UBS, called the weakness in Aetna's shares “short-term noise.”
Investors were similarly cautious after Aetna's 2012 bid for Coventry Health Care, which provided its first entry point into the government space. But during the 8.5 months between the deal announcement and its closure, Aetna's shares gained 55.4%, Rice wrote in a research note.
In addition to Humana's government offerings, both companies share a similar vision about creating a consumer-focused company with a strong focus on care management and population health, Bertolini said on the call.
The $37 billion price tag values Humana at $230 per share, of which 54% will be paid in cash and 46% will be paid in stock. The offer represents a 29% premium to Humana's share price before speculation that the company could become a takeover target. It also includes the assumption of debt.
Aetna is projecting $1.25 billion in annual synergies from the deal starting in 2018, which will come from a modest overlap in the insurers' provider networks as well as medical management synergies, Aetna CFO Shawn Guertin said on the investor call.
The company also is anticipating $1 billion in one-time, pretax transaction costs through 2019.
Humana will maintain its brand and its Louisville headquarters after the deal closes.
The July 3 deal came the same week that Centene forged a $6.3 billion takeover offer for Health Net, which is a significant player in Medicaid managed care. Anthem, meanwhile, has offered about $47 billion in cash and stock for Cigna.
The wave of consolidation comes after an extended period when insurers have been relatively quiet on the acquisition front, preferring smaller transactions that built expertise in adjacent areas such as care management.
Windley suggested that insurers needed enough time to digest prior blockbuster deals before returning to the bargaining table. But he acknowledged that some of the business uncertainty had recently been removed when the Supreme Court upheld insurance subsidies for people buying health plans from a federal marketplace. A ruling in the other direction could have created an adverse risk pool if healthier people decided that they didn't want to pay more for coverage.
Although the negotiations predated the King v. Burwell decision on June 25, final deal announcements might have been left to simmer until the outcome was announced.
“I think there's a possibility that they waited,” Windley said.