“In managed care, we were pleased, if not elated, to see two transactions announced amongst our four portfolio holdings that are each significantly value-creating for both buyer and seller and came at meaningful premiums. In acquiring Humana, Aetna is purchasing a stronger growth business with greater organic growth (>10% top-line) in a transaction we believe will be mid-teens accretive to earnings per share in the near-term and greater than 20% accretive in the out years following synergies from each PBM operation. In acquiring Cigna, Anthem will achieve greater than 20% accretion in the near-term and as much as 30% accretion when the full PBM savings are captured late this decade. We have done extensive anti-trust analysis on each situation, and believe the odds of a completed deal between Aetna and Humana are exceedingly high, while a combination between Anthem and Cigna is highly likely to close as well. Despite our views, each arb spread is trading at 27% and 33% respectively, and each acquirer has seen their shares decline on average 16% despite the 15-30% accretion from the deal. In retrospect, we attribute this share price weakness to the following factors:
1. Risk aversion from traditional arb and event funds who have had very challenging conditions over the past 18 months, several of whom have liquidated;
2. Time arbitrage, with the deals unable to close in calendar 2015, causing investors to feel they may sell today and come back another day;
3. Concerns regarding the statements of political candidates during the election cycle that express populist concerns regarding the potential for market power coming from such consolidation; and
4. Fear that they are heavily owned by hedge funds, including Glenview, who have had poor performance, and as such that those funds will be forced sellers and create better buying opportunities later.
Looking forward in managed care, we own four names, Aetna, Anthem, Cigna and Humana. As mentioned Aetna has announced the acquisition of Humana and Anthem has done the same for Cigna. We have strong conviction in these names even without the mergers going through and view the mergers as adding a compelling asymmetric upside to the names. Take for example the Anthem and Cigna deal (illustratively, Aetna and Humana are in a similar situation). Anthem is trading at 11x 2017 standalone EPS (and <10x including the stand-alone earnings opportunity from its PBM). Cigna is trading at ~12x 2017 standalone EPS. Each company has projected a standalone EPS CAGR of 13-14% from 2015-2018. Should this transaction fail to receive anti-trust approval, we see 20-35% annualized returns in the names through the end of 2016. However, we do believe this transaction is highly likely to receive approval (we will discuss our anti-trust views of each transaction in further detail at our Investor Day on November 12th). Pro forma for the transaction, Anthem is trading at under 10x 2017 EPS, and should grow high-teens from 2017-2019 as the full accretion for the deal comes in. In this event we think Anthem’s stock could return almost 50% annualized return by year end 2016. Further, we think Cigna could achieve 50-70% annualized returns between now and deal closing.”
Keeping this in mind, let’s check out the latest action regarding Humana Inc (NYSE:HUM).
