** Draft: This will
go through several iterations of updates.
Why I like Managed
Care Organizations (MCO)
The secular growth story of healthcare sector is not hard to
understand. Aging population and
Obamacare expands the size of the pie; while government budget constraints
means private sector gets a larger share of that pie. This applies not only to
PBMs (which I have written about in another article), but also helps MCOs. For
MCO’s specifically, the exchanges mandated by ACA also provide opportunities to
lure some of the Administrative Services Only (ASO) business to full risk
business, which has higher profit per member (by 4x in some estimates).
These are good businesses that are relatively simple. Compared
to say, a life insurance company where you have all kinds of derivative
exposures and quality of earning concerns, health insurance is much simpler because
these are annual contracts. Furthermore, MCO’s are not pure risk businesses. In
general there’s a large service component which is less capital intensive and
high return (Nice ROE in the mid/high teens). Low capex also means strong cash
flows and thus optionality to deploy capital.
Industry structure is fairly attractive. This is a fairly
concentrated industry with several established national players (will discuss
later). Other than the government, customers are fragmented and have low
bargaining power. While some parts of the supply chain have consolidated (PBMs,
distributors for example), providers (hospitals, physicians…etc) will likely
remain fragmented. As large customers MCO will exert power to push prices lower
for the benefit of consumer. Keep in
mind that health plans are essentially commodity products so brand recognition
is important. When you’re selling what’s basically a financial service, there’s
just not much differentiation. How many customers can really tell the
difference between UNH, CIG, AET? In my
old company, where it comes time to pick health plans, most people just ask
their friends (blind leading the blind) or randomly choose one. Despite being a
commodity, barrier to entry is extremely high due to state level regulations,
capital requirements, and the need for a provider network.
Why now?
1.
Valuation. Managed care is one of the few
sectors that are still reasonably priced. The chart below shows that valuation has
increased but still not high by historical standards
2.
Mitigate risks in portfolios. People always need
healthcare. In the past health plans do get hurt by unemployment in a down
cycle, but I’m guessing demand should be more constant in the future due to
individual mandates. Although I don’t know
where rates will be headed, higher rate is a general risk factor, and Managed
Care is one of the few sectors where rising rates would help (through higher investment
income)
Key players:
UnitedHealth
Group Inc (UNH)
- Large
& diversified business: UnitedHealthcare
+ Optum Health Services
- Exposure
to NY where competition is intensifying according to management. Bad star
ratings hurt its MA business.
- Amazing
streak of beating estimates all the way back to 2009. Aggressively retuned capital to shareholders
2010-2013
- Has
its own PBM
Wellpoint
Inc. (WLP)
- Largest
provider of Blue Plans. About 20% of members from government business (12%
from Medicaid)
- Management
levers
- Uniquely positioned to consolidate
other Blue plans
- PBM “optionality”. WLP currently uses Express
Scripts. However there’s a good
chance they that WLP will either renegotiate better terms or otherwise
extract another payment from ESRX.
- Consistently
the lowest margins and ROE among big 4.
- Has
hedging value if you own ESRX
Aetna
Inc. (AET)
- EBITDA
Mix: 39% large group insured, 24%
commercial fee business, 22% government; 15% small group/individual/group
insurance. Membership mix: ~15% government (7% Medicare)
- Sensible
goals and strategies in my view. AET aspires to double revenue by 2020 and
achieve double digit EPS growth with 5% organic and 5% capital deployment. To that end, management plans to increase
government profit substantially over next few years.
- Grow Medicare Advantage (MA) &
dual eligible. AET is well
positioned in MA to do this as they have strongest STAR scores. AET is also aggressively getting into
the public exchange business where clients are more likely to be full
risk, which has higher margins.
- PBM
relationship with CVS.
Cigna (CI)
- Traditionally
has the least risk business (more of ASO)
- “Go Deep. Go Global. Go Individual”
strategy. Low commercial member growth but go for deeper product
penetration.
- Has
Catamaran as its PBM
Humana (HUM)
- Medicare
focused, roughly 35/35/25 in retail/employer/healthcare services
- 68%
government business almost 90% risk). Particularly Retail MA & Medicare-PD. Not much Medicaid
- Looking
to sell its PBM
At this point, I
favor Aetna.
·
Actually, I’d buy all of the above. So it’s a
matter of maximizing value by buying at the best prices.
·
I particularly like Aetna. It has a coherent
strategy to increase earnings matched with action. For example management wanted
to get more Medicare business, so they bought Coventry and have a high percentage
of members in high STAR rating plans. I also like how they’re aggressively
getting into exchanges.
·
Good operator.
AET consistently has one of the higher margins in the group. Both AET and UNH aggressively bought back
stocks over the past few years which in retrospect were greatly accretive.
Compare to UNH however, AET trades at a lower multiple and is more of a pure
play MCO.
·
Key things to watch out for in 2014 are how they
manage to offset MA
rate pressure & ACA fees; progress in Coventry integration.
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