Thursday, August 9, 2012

Why I Own WLP

Wellpoint (WLP) is one of the biggest MCO (managed care organization) in the US. They offer the Blue Shield/Blue Cross name in 14 states. WLP is my second largest holding. I have owned it for 8 years since when it was originally Anthem.

The US spends 1/6th of its GDP on health. So health is a big sector US equity market which is looking very hard for inefficiencies. MCOs are in the business of increasing efficiency. (some may argue this is all at the expense of the quality of service, but I will stay away from that as this post is about the investments merits of MCOs)

I chose WLP in part as a play on the overall healthcare and MCO sector. Blue Cross/Blue Shield is a great franchise, and they are well managed. What amazes me about WLP is the P/E of 8. Usually when companies have P/E that low they have some big inherent risks such as huge debt or loss of market share or they are highly cyclical. WLP is not cyclical, their earnings have been rising. They are not overly burdened by long term debt. The balance sheet does show that their tangible book value is about zero. This means the company's value is in the franchise, the organization and its scale.

So where is the catch? Well the catch is supposedly Obamacare. The pervasive feeling is that the government will regulate and restrict the sector. And companies like WLP will not have freedom to raise rates as freely.

This fear is a valid one, but one must also consider the flip side of this. Obamacare will bring 30 million new members to MCO likes WLP. It is somehow very counterintuitive to me that the industry will suffer even with 30 million new members. For now I will give this argument the benefit of the doubt, but even then I think the P/E of 8 overly discounts the risk.

As for recent news, there was a lot. WLP was trading at about the $70/shr range for the last year, until June when the Supreme court released the verdict that upheld Obamacare. That caused it to drop to $60. Then WLP released earnings in July, they disappointed which drove the stock to as low at $50. That puts the current P/E at 7! The earnings report showed that membership was lower, and they also gave a lower than previous earnings guidance of 7.35. Overall, I read the stock movement as a knee-jerk reaction to the unknown. Sure the managed care landscape is changed forever, but uncertainty can bring danger as well as opportunity. I have found that the market reacts to big negative headline situations by unnecessary panic selling. Which brings me to my next point.

Every year or other year some unprecedented negative media attention comes to a company. The news is due to some event that is pretty much out of the company's control. It isn't the management's fault, it is just the risk of doing business for that company or its industry. But because the bad press is sudden and pretty much unprecedented, the market doesn't can't digest it quickly enough. This in turn comes can cause some wild swings. I feel this is a case where I can try to take advantage. This type of situation does require patience, like a predator stalking its prey. It could take years of waiting but there is money to be made.

To show my point, I have listed the cases that I know of and how one could have made money.
Date of Low Company Event Low Price Later Price
8/2000 Philip Morris Engle's class action suit against big tobacco awarded $145 billion to the plaintiffs, later overturned. $26 now: up approx 7-10x after 2 splits to make PM and KFT and dividends
9/2004 Merck Vioxx recalled. This anti-flammatory drug was purportedly responsible for many deaths. Taken off the market then reinstated $26 $46 two years later
6/2006 Bausch and Lomb ReNu solution seemed to be related to dozens of cases of blindness due to a fungus, relationship never proven $45 taken private in 2007 for $65
6/2010 BP Gulf of Mexico spill $27 $40 today
6/2012 WLP Supreme court ruling in favor of Obamacare $50 TBD

Disclosure: I own KFT and PM.

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