Sunday, January 31, 2016

Playing Anthem-Cigna Merger Arbitrage

The managed care industry is under pressure by shareholders and regulators and the public to decrease costs while increasing coverage for the needy. It has done a lot to that end but the next step looks to be consolidation. Anthem (ANTM) last year announced plans to merge with Cigna (CI) last year. Similarly Aetna (AET) last announced plans to merge with Humana (HUM). These two mergers have the potential to change the managed care industry from five big providers to three big providers.

Revenue Members Notes
United Health$154 B 45.7 M Big on Medicare and Medicaid
OptumRx for perscription benefit
ANTM + CI$117 B 53.8 M ANTM: BCBS provider in 14 states and public exchanges
CI: Medicare and international and national accounts
AET + HUM$115 B 33.5 M AET: strong in Medicare and public exchanges
HUM: Big on Medicare


In this deal, Anthem would give $103 plus 0.5152 Anthem shares for each CI share. The potential value to CI shareholders is shown below. Anthem last year traded in the $125-170 range. The last ANTM and CI values are also shown in the chart. Note that CI is trading $35 below the merger price if the merger is consummated with ANTM trading at the most recent price. This huge discount reflects the high uncertainty of the merger passing regulatory scrutiny. However, in CEO's of both companies said in conference calls they were confident of success.



The deal also has a lucrative $1.85 B breakup fee payable by Anthem to Cigna if the deal cannot consummate by next year due to regulatory snags. That is about $6 to each CI share! In the event that the merger fails due to regulatory snags, I conservatively estimate the CI price to be 13x the expected $8.50 year-end earnings guidance, plus the $6 breakup fee minus taxes. That works out to about $115 per CI share. That is the bottom limit of the chart.

I used a 13x multiple for CI because CI has a better than average profit margin (6%) than other managed care companies such as ANTM. While managed care companies now typically have multiples in the mid to high teens. Based simply on the CEO's comments, I give the deal a 60% chance of success. So to me, CI looks like a easy way to get a good one year return. In addition, I had a large ANTM position coming in. So it was most logical to do a merger arbitrage. Merger arbitrage typically calls for shorting the acquirer and buying the acquiree. So, I sold part of my ANTM position and bought CI. If the deal does happen I grow back part of my ANTM position. If the deal does not happen I own CI which is a sound company in an industry I like, albeit I paid a higher price than I liked.

No comments:

Post a Comment