They were two mega mergers that would have changed the face, and no doubt the complexion, of health care insurance and management. Anthem Inc. (ANTM, Financial) wanted to merge with the much larger Cigna Corp. (CI, Financial), while Humana Inc. (HUM, Financial) and Aetna Inc. (AET, Financial) also wanted to go to the altar.
In June 2015, Anthem announced it planned to buy Cigna, a global health insurance services company (Anthem is a domestic company). A month later, Anthem and Cigna announced a definitive agreement, putting the value of the deal at $54.2 billion.
Earlier this month, however, a U.S. District Court judge blocked the merger on anticompetitive grounds. In the wake of that decision, Cigna said it was no longer interested in the deal, accused Anthem of stealing confidential information and initiated legal action. Anthem responded by countersuing, preventing Cigna from terminating the deal.
As we know from the news, Aetna’s plan to buy Humana was also tripped up in court.
To add to the cascade of bad news, the stock prices of all four, plus that of UnitedHealth Group (UNH, Financial), took a tumble on Friday's news about the repeal and replacement of the Affordable Care Act, plus news that the U.S. Justice Department is joining a whistleblower lawsuit against UnitedHealth.
As a result, the price of Anthem’s shares dropped by more than 3% at the close on Friday, after setting a 52-week high. Does this pullback and the profusion of bad news make Anthem an attractive buy?
History
According to the company's website, what is now known as Anthem Inc. began as two companies. On the Anthem side, it involved the creation of Mutual Hospital Insurance Inc. and Mutual Medical Insurance Inc. in Indianapolis, Indiana, in the mid-1940s. On the other side, WellPoint Health Networks was created by Blue Cross of California to operate its managed care business.
Through the years, both companies grew, particularly through mergers and acquisitions. The targets of the acquisitions were often non-profit Blue Cross organizations. Anthem, an insurance company, demutualized in 2001 and merged with WellPoint in 2004 to become WellPoint Inc. In turn, WellPoint Inc. went on to enlist on the New York Stock Exchange in 2004 under the symbol WLP. Finally, WellPoint changed its corporate name to Anthem, and its NYSE symbol to ANTM, in 2014.
While the name may have changed, the strategy of growth through acquisitions did not. Recent major acquisitions include CareMore in 2011, 1-800 CONTACTS in 2012 (and subsequently divested in 2014), Amerigroup in 2012, Simply Healthcare in 2015 and, of course, the Cigna deal.
Anthem and WellPoint made dozens of acquisitions and went through numerous mergers before and after their own merger. Even without the Cigna deal, this company has made many significant acquisitions.
Anthem’s business
The company continues its relationship with Blue Cross and Blue Shield as a licensee; at the end of December 2015, it was a Blue Cross licensee in 14 states or parts of states. In many states, it does business as Anthem Blue Cross. It also does business through subsidiaries Amerigroup, Simply Healthcare, HealthLink, UniCare and CareMore. Through these entities and Blue Cross licenses, it does business in all 50 states.
The company offers, “a broad spectrum of network-based managed care plans to large and small employer, individual, Medicaid and Medicare markets.”
Its managed care plans include:
- Preferred provider organizations (PPOs)
- Health maintenance organizations (HMOs)
- Point-of-Service plans (POS)
- Traditional indemnity plans
- Hybrid plans, including consumer-driven health plans (CDHPs)
- Hospital only and limited benefit products
Other products and services include claims processing, underwriting, actuarial services, wellness programs and specialty products such as dental, vision, life and disability insurance.
Anthem says managed care products such as HMO, PPO and hybrid plans have been developed because employers, governments and consumers want alternatives to traditional indemnity health insurance, alternatives which would cost less.
It operates through three reportable segments:
- Commercial and Specialty Business: a mix of managed care products, including PPOs, HMOs, traditional indemnity benefits and POS plans. It also offers a variety of hybrid benefit plans, including CDHPs, hospital only and limited benefit products.
- Government Business: includes Medicare and Medicaid businesses, National Government Services and services provided to the federal government in connection with FEP (Federal Employee Program).
- Other: “businesses that do not meet the quantitative thresholds for an operating segment as defined by Financial Accounting Standards Board, or FASB, guidance, as well as corporate expenses not allocated to the other reportable segments.”
Anthem is a major player in managed care with a broad range of products and services it sells to companies, governments and consumers. A significant piece of that business can be attributed to its affiliation with Blue Cross and Blue Shield.
Revenue
Anthem had total operating revenue of $84.2 billion in 2016, an increase of 7.4% from 2015, according to the fiscal fourth-quarter 2016 financial report.
This chart shows the growth of revenue over the past decade:
By segment, revenue for 2016 broke out this way:
- Commercial & Specialty: $38.692 billion
- Government Business: $45.478 billion
- Other: $24.2 million
As of the end of fiscal 2016 (Dec. 31), Anthem had membership enrollment of 39.9 million, an increase of 1.3 million (3.4%) over the end of 2015.
As an insurer, the company maintains an investment portfolio; at the end of fiscal 2016, its value was $567.7 million, made up of net unrealized gains on equity and fixed maturity securities.
Anthem generates significant amounts of revenue from each of its two main segments. Its revenue has grown fairly steadily over the past decade.
Competition
Hoover’s lists Anthem’s three main competitors as Aetna, Cigna and UnitedHealth Group. Adding Humana rounds out the list of what’s known as the Big 5 of health insurance.
In its annual filing with the SEC for 2015, the company says, “The managed care industry is highly competitive, both nationally and in our local markets. Competition continues to be intense due to aggressive marketing and pricing, business consolidations, a proliferation of new products, the impact of Health Care Reform and increased quality awareness and price sensitivity among customers.”
As this GuruFocus-generated table shows, Anthem is the second-largest by revenue and third-largest by market cap:
The table shows how the proposed mergers of Aetna and Humana and Anthem and Cigna might have radically changed the look of the industry. However, whether either or both succeed or fail, the market will remain intensely competitive.
Moat
Morningstar assigns a Narrow Moat rating to Anthem.
GuruFocus reports that Anthem’s operating margin has been retreating, “Anthem Inc.'s operating margin has been in five-year decline. The average rate of decline per year is -3.1%." The operating margin is the subject of a GuruFocus Severe Warning signal.
The company says it believes competition is based on “quality of service, price, access to provider networks, access to care management and wellness programs (including health information), innovation, breadth and flexibility of products and benefits, reputation (including National Committee on Quality Assurance, or NCQA, accreditation status), brand recognition and financial stability.”
Note that price is second on this list.
Still, it has some competitive advantages, including major investments in technology to facilitate interaction with providers, employers, members and third parties; its exclusive right to market itself under what it calls “the most recognized brand in the industry, BCBS (Blue Cross Blue Shield)”; and the ability to use predictive modeling, proprietary research and data-driven processes to price its products.
A narrow moat is a reasonable assessment given the number of well-financed and well-capitalized competitors, and its own competitive advantages.
Growth
Historically, Anthem has grown both its top and bottom lines.
Revenue per share growth metrics averaged:
- Three years: 10.6%
- Five years: 14.0%
- 10 years: 13.9%
EBITDA (earnings before interest, taxes, depreciation and amortization) average annual growth:
- three years: 5.0%
- five years: 5.0%
- 10 years: 0.9%
EPSĂ‚ growth, averaged annually:
- Three years: 2.0%
- Five years: 4.8%
- 10 years: 6.7%
Anthem says in its 10-K that it plans to expand through a combination of organic growth, strategic acquisitions (including the now unlikely merger with Cigna) and efficient use of capital in both existing and new markets.
It further notes that it sees additional economies of scale, access to new and evolving technologies and opportunities from geographic and product diversity. Additionally, it thinks more of the same is important for growth, “...we have also achieved organic growth in our existing markets over time by delivering excellent service, offering competitively priced products, providing access to high-quality provider networks and effectively capitalizing on the brand strength of the Blue Cross and Blue Shield names and marks.”
Demographics could be a key growth driver, according to an undated but recent article at Vault.com, “Covering the Medicare market is a significant part of Anthem's growth strategy: The company anticipates more than 1 million baby boomers will become eligible for Medicare every year between 2011 and 2030 in all of Anthem's Blue-branded states, and it is beefing up its Medicare offerings and expanding into new service territories to prepare for the change.”
Anthem has a history of growing both its revenue and its earnings and should be able to maintain those levels, although perhaps not as robustly as it might with a Cigna merger.
Other
Anthem is incorporated in Indiana and headquartered in Indianapolis.
According to Reuters.com, Chairman, President and CEO Joseph Swedish has been a director and CEO since 2013. Prior to Anthem, he served in management positions at other health companies. Chief Financial Officer and Executive Vice President Wayne DeVeydt has been CFO since 2007. Previously, he had been with PricewaterhouseCoopers LLP.
Ownership
Among the gurus followed by GuruFocus, 23 own shares in Anthem. Largest among them is Barrow, Hanley, Mewhinney & Strauss with 8,053,028 shares, good for a 3% stake in the company. Second and third-largest are Larry Robbins (Trades, Portfolio) and Hotchkis & Wiley.
As this GuruFocus table shows, institutional investors own most of the outstanding shares:
Shorts hold a small position while insiders also hold a modest number of shares. The latest insider transaction records show Swedish owning 71,034 shares as of Dec. 12, 2016 and DeVeydt holding 69,607 shares as of Sept. 8, 2015.
Anthem has a solid and stable shareholder base made up mainly of institutional investors, while the two top executives have modest holdings.
By the numbers
The current share price (at closing on Feb. 17) is 3.4% below the 52-week high; there is a significant gap between the trailing P/E and the forward P/E; the ROE (return on equity) is in double digits (barely); it pays a small dividend; and it issued new shares in 2016.
Financial strength
Anthem gets a middling rating for financial strength, and a strong rating for profitability and growth:
The company had long-term debt of $14.359 billion at the end of fiscal 2016, down roughly $1 billion from the end of 2015. Total debt per share at Dec. 31, 2016 was $59.70. This chart shows the level of debt over the past decade:
As noted above in the Revenue section, Anthem has grown its revenue through most of the past 10 years. The earnings line for EBITDA, though, is not as encouraging, despite it being a 5-Star Predictability company:
The EPS lines look better than EBITDA:
And this is the bumpy free cash flow chart for the past 10 years:
Anthem’s weighted average cost of capital (WACC) is 6.39%, while its return on invested capital (ROIC) is 13.67%.
Looking at the metrics above, predictability does not seem its strong suit, even on earnings. Still, the company has used its capital effectively to grow and operate.
Valuations
Having questioned the predictability of Anthem’s metrics, despite its 5-Star earnings predictability rating, it is time to look at specifics.
Since the company’s fourth-quarter 2016 earnings are reported in net income, this chart shows that net income in the context of 10 year’s history:
Only two of the seven GuruFocus valuations produce positive results, which is to say, valuations above the current price:
Analysts followed by NASDAQ.com have a 12-month consensus price target of $166, roughly 3.5% above the current price, and they are slightly bullish:
In a 10-year historical context, the current P/E (17.40) is at the high end of its range:
The PEG ratio (P/E divided by the five-year average annual earnings growth rate) comes in at 1.50, which is right in the middle of the fair value area (ratios of less than 1 are considered undervalued; those 2 and above are consider overvalued).
The share price has been above the 200-day Simple Moving Average since November:
Most of the GuruFocus estimates and the current level of the P/E ratio suggest Anthem is overvalued, while the analysts’ price target and the PEG ratio suggest fair valuation. Either way, there is no apparent, compelling reason to look at the company as a value stock or underpriced.
Conclusion
Perhaps the view on Anthem might be more positive if the proposed merger with Cigna was still on solid ground; the bigger Cigna has some robust metrics that would make a new merged entity an interesting prospect. But, it seems unlikely the merger will occur now.
So, Anthem needs to be evaluated on its own terms, its own history and future. The company does have a reasonable history, as evidenced by the strong interest of institutional investors.
As for the future, not only is there company uncertainty, but also industry uncertainty as the federal government wrestles with the future of the Affordable Care Act, or whatever replaces it.
For individual investors, particularly value investors, it is a time to wait for either a major pullback of the share price or greater certainty about Anthem’s path ahead.
For investors who want health care exposure now, see my articles: "Cigna Is an Excellent Prospect, Regardless of Anthem Deal"Ă‚ (from August 2016) and "WOOF: Health Care Without the Drama."
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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