Will they or won’t they get to the altar?
The proposed buyout of Cigna Corporation (CI, Financial) by Anthem Inc. (ANTM, Financial), two major players in the health insurance industry, was announced publicly almost one year ago this week on July 24, 2015. News of the deal came out just three weeks after Aetna Inc. (AET, Financial) announced it planned to buy Humana Inc. (HUM, Financial), both are also major players in the industry.
But neither deal has yet been consummated, and may never be, because of their potential to reduce competition in the industry. Regulatory approval is needed, and many players are pressing hard to ensure neither proposal gets a positive ruling.
This leaves us to wonder: If Cigna is not bought by Anthem, is this denizen of the Buffett-Munger screener worth buying at its current depressed price?
Cigna’s history
- 1792: Cigna’s first predecessor company, selling marine insurance, is established by a group of Philadephia citizens.
- 1865: A second predecessor company specializing in life insurance is created.
- 1982: Cigna is established by combining these two companies, which by then had become active in health insurance.
- 1998: Sells its life insurance and annuities businesses.
- 1999: Sells its property-casualty insurance business.
- 2015: Reaches a deal to be acquired by Anthem.
Based on information provided at the company website.
Cigna’s business
According to its 10-K for 2015, Cigna Corporation operates in the medical, dental, disability, life and accident insurance fields; it also offers related products and services through subsidiaries. Its operations fall into three reportable segments:
- Global Health Care.
- Global Supplemental Benefits.
- Group Disability and Life.
Global Health Care, the biggest group of the three, is divided into two sub-segments:
- Commercial segment: serves employers, other groups, and individuals with medical, dental, behavioral health, vision, and prescription drug benefit plans, health advocacy programs and other products and services.
- Government segment: provides Medicare Advantage and Medicare Part D plans to seniors and Medicaid plans.
Global Supplemental Benefits:
- Supplemental health, life and accident insurance products in selected international markets and in the U.S.
Group Disability and Life:
- Group long-term and short-term disability, group life, accident and specialty insurance products and related services.
The biggest contributor to both its revenue and earnings is Global Health Care, as this excerpt from its 2016 Investor Presentation shows:
Global Health Care accounted for 79% of revenue in 2015 and 76% of adjusted earnings.
Looking at its revenues in more detail, we see in this excerpt from the 2015 10-K that insurance premiums are the big bread winner:
And, of that revenue, just under 90% comes from the United States, and just over 10% comes from other countries:
Health insurance accounted for nearly 80% of Cigna’s revenue and earnings in 2015, and while the company writes of having a presence in 30 countries, foreign sources account for only about 10% of revenue. All of this means Cigna remains exposed to the intense competition and vagaries of government policy in the U.S.
The potential buy-out
On July 24, 2015 the company announced it had reached agreement with Anthem to merge the two companies, and that Anthem would be the surviving entity.
The proposed $54.2 billion dollar buyout would provide a 38.4% premium to the holders of Cigna shares, based on the closing prices of May 28, 2015. This would comprise $103.40 in cash and 0.5152 of a share of Anthem common stock; as a Reuters story explained, “The deal is valued at $181.12 per share based on Anthem's Friday close of $150.86.").
Just three weeks earlier, Aetna announced it had made a deal to buy Humana for $37 billion. If both deals are allowed to go through, the industry will be consolidated into just three national health insurers. As the Reuters article noted, this immediately raised alarms among industry watchers and other players in the health care system, “Within a few hours of the announcement, several U.S. lawmakers and a leading physicians group said they feared the pending acquisitions would hurt consumers by raising prices or limiting access to healthcare providers.”
As of the publication of this article, both deals remained in limbo; a headline in an Investor’s Business Daily neatly summed the situation a week ago, “Humana Dives On DOJ Concerns Over Aetna Takeover Bid”.
In its 10-K for 2015 (published in February) Cigna said it expected its deal to close in the second half of this year.
The outlook
If the deal goes ahead, it will get a warm welcome from Cigna shareholders; their shares closed at $130.02 on July 14. That’s well below the $181.12 spelled out in the deal (not that it would be worth that much today. Since the deal was announced, Anthem shares slumped from $150.86 to $133.01, making that half Anthem share worth less).
If the deal doesn’t go ahead? No doubt Cigna will continue on as it has, presumably returning the same sorts of top and bottom line results. In a following section, we will review its potential.
While the agreement with Anthem faces significant hurdles, it could deliver a windfall to owners prepared to wait patiently for a deal that might not happen.
Cigna by the numbers
The share price currently sits closer to its 52-week low than its high; the dividend is essentially nothing but it has bought back quite a bit of stock, and the company has delivered a healthy ROE of more than 17%.
Ownership
Of the investing legends followed by GuruFocus, 22 have holdings in Cigna Corporation. Dodge & Cox is the biggest, with more than 13.5 million shares (as of March 31 this year). Vanguard Health Care Fund (Trades, Portfolio) and Larry Robbins (Trades, Portfolio) are the next two biggest owners.
Institutional investors, including many of the gurus, own almost all this company: 93%, according to GuruFocus. It also reports minimal insider ownership of 0.04% by insiders and 0.99% by short interests.
An overwhelming institutional ownership suggests this stock has survived reviews by many fund managers and professional investors. Short interests are also low, so we might say the market has confidence in Cigna.
Financial strength
Cigna gets middling marks for financial strength from the GuruFocus automated system:
A quick glance at the two columns under the Financial Strength heading gives us a clue about the middling mark for Financial Strength: Debt.
It finds Cigna's Cash to Debt ratio mediocre, compared to the industry, and downright disappointing compared to its own history. In addition, it does not like Interest Coverage situation, again in the context of its own history. Let’s look at a chart of that debt:
As the chart makes clear, Cigna’s long-term debt grew rapidly for several years, then plateaued. At the same time, its free cash flow remained relatively flat and its EBITDA grew:
Over the last five years, the company has spent heavily on share repurchases, an average of almost $744-million per year according to the 15-year financials at GuruFocus.
That spending on share repurchases has helped the company improve its EPS:
Although Cigna Corporation loaded up with long-term debt over the past decade, it has also managed to grow its EBITDA, repurchase shares, and boost its EPS.
Valuations
Cigna's intrinsic value, based on a DCF fair value calculation comes in at $132.81, a dollar and a few cents above its closing price on July 15.
To make it onto the Buffett-Munger screener, a company must have four key characteristics:
- High predictability rank.
- Competitive advantages (a moat).
- Little debt.
- Fair-valued or undervalued, based on PEPG or PEG (Price/Earnings divided by the average growth rate of EBITDA over the past five years.
Cigna clearly meets three of those criteria:
- It has a predictability rank of 4 (out of 5), which good;
- It enjoys a brand that has been around, in one form or another, for more than 200 years
- Debt is the contentious issue, obviously, and
- It has a PEPG or PEG ratio of 1.12, which puts it at the low end of the fair-value range.
Other GuruFocus writers and/or analysts have also weighed in Cigna recently:
In his article, 9 Best Stocks for Value Investors This Week, Benjamin Clark wrote “As for a valuation, the company appears to be undervalued after growing its EPSmg from $4.84 in 2012 to an estimated $7.82 for 2016. This level of demonstrated earnings growth outpaces the market's implied estimate of 3.87% annual earnings growth over the next seven to 10 years. As a result, the ModernGraham valuation model, based on Graham's formula, returns an estimate of intrinsic value above the price.”
James Li wrote, in Stocks Near 52-Week Lows, “Jim Simons (Trades, Portfolio) of Renaissance Technologies LLC increased his position in Cigna by 977.08%. Cigna attracted Simons and other investors due to near one-year low P/B and P/S ratios, near one-year high dividend yields and consistent per share revenue growth.”
For a value investor, and for anyone who follows the lead of Warren Buffett (Trades, Portfolio), Cigna’s debt will be a problem. Beyond that, the current price should be considered fair, or even at the low end of fair valuation on the PEG scale.
Conclusion
Investors often say they like to get paid while they wait. They’re saying dividends compensate them for the time they have to wait for a capital gain.
In the case of Cigna, the prospect of a sizable gain from a buyout may make it worthwhile to buy Cigna now and hold. While we don’t know what (roughly) half a share of Anthem will be worth when or if the buyout closes, the total received per Cigna share will likely be materially above the current price. As you will recall, Cigna shareholders are to get $103.40 in cash and 0.5152 of one Anthem share for each Cigna share.
If the deal fails to go through, and there are many critics of the deal, then it’s possible we will see another dip in the share price. However, any pullback should be short-lived, because Cigna does have the earnings power to put its share price back on the upward track.
In fact, a pullback caused by a failed deal might offer an excellent opportunity to buy a good company at a very good price.
Disclosure: I do not own any shares in the companies listed in this article, nor do I expect to acquire any in the foreseeable future.
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