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.

2014 Good Year for Insurance

My insurance holdings are all doing well in 2014. I am not a swing-for-the-fences type of guy. I'd much prefer staid consistent returns. And insurance companies give me that — for now. Insurance companies are strictly regulated in the US. An insurance company requires a license from state regulators in whatever state it wants to operate. The regulators set guidelines for drawing up the liabilities, i.e., the reserves. This is especially true for life insurance companies. People's life expectancies are very well understood, and when a company combines thousands of policies together, the result is a very predictable income and payment stream. Life insurance is also a commodity because there is little room for innovation. For these reasons, life insurance companies are in a competitive low-margin business. On the other hand, many trade considerably below book. Kansas City Life (KCLI) is a case in point. The company's 3 month and 9 month earnings so far this year are in line with last year. But this is just a 4% return on equity! This is a paltry return for a company with no top line growth.

I also own AIG. AIG specializes in both life and property and casualty (P&C). The company's third quarter results was pretty much inline with a year ago period. AIG is now in its first quarter without Benmosche as CEO since 2009, when he steered the company out of the financial disaster. AIG's return on equity is better than KCLI but its relative market to book value is about the same, as shown below. But AIG is a more dynamic company and has much greater potential to improve results despite its larger size.

For comparison purposes, I have also included in the table two life insurance companies that I do not own. Independence Holdings (IHC) sells life and health insurance, and National Western Life (NWLI) sells life insurance along with a lot of annuities. The final insurer in the table is European Reliance (EUPIC). This company sells life, health and car insurance, among other services. It looks better than the others by all metrics. The downside to the company is that it is in Greece. But I bet few would know that after four years of negative GDP, the country is poised to be positive again in the coming quarter. And in my opinion, the dirt cheap stock price gives me ample margin of safety against the company's risks; I EUPIC is a much better stock to own than KCLI. And therefore, I plan to close my KCLI position and use the proceeds to add to my EUPIC position.

	KCLI	AIG	IHC	NWLI	ATH:EUPIC
Price	$ 50.000	$ 54.000	$ 14.220	$ 271.970	€ 1.440
Market Cap	548.40 M	75.60 M	249.96 M	988.88 M	€ 39.60 M ($ 49 M USD)
P/E TTM	19.5 x	8.5 x	10.9 x	9.4 x	3.9 x
Div yield	2.2 %	0.9 %	2.5 %	0.1 %	0 %
P/BV	0.72	0.70	0.85	0.64	0.60
ROE	3.7 %	8.2 %	7.8 %	6.9 %	15.5 %
ROA	0.62 %	1.68 %	1.95 %	0.94 %	3.25 %

ITIC also reported earnings. The company earned $7.0M for the first 9 months versus $13.0M last year. This dramatic drop was not because of a drop in revenue, which was only slightly down, but due to positive effects of claim provisions last year. ITIC sells title insurance; however, I don't really think of it as an insurance company like the other five mentioned in the earlier table. Title insurance claims are a tiny fraction of the premium — less than 10% — and they don't take long to occur. If a claim is made on a policy it usually happens within a few years after purchase. Also, part of the cost of the title insurance policy is the title search that the insurer must perform. So, ITIC can be considered a service company as much as an insurance company.

And my fifth and final insurance company, Wellpoint, reported Q3 revenues up 4% and income up 3%. And most importantly, year end EPS guidance is now around $8.88, up from $8.81. The stock has gone up almost 40% year-to-date. Even the midterm elections last week couldn't drag it down. The Republicans now control both houses of Congress and now can ram through legislation to repeal Obamacare. Their rhetoric says they will too. Of course if they do president Obama will veto it and the Republics do not have the votes to override the veto.

Still, I was pleasantly surprised at the lack of reaction from the market. But I am really not at all concerned by the election results. Obamacare is most widely know for the individual mandate, which is mostly provided by the public exchanges. But the public exchanges only provide 750k customers out of 37M. Wellpoint is doing well now mainly because of better management and the benefits from medical insurance expansion through many aspects of Obamacare. If the Republicans do succeed somehow in changing healthcare, it will only be to tweak this system of private insurance with subsidies for the poor. But the spirit of Obamacare is here to stay. So Wellpoint will benefit no matter which party runs the government after Obama leaves in 2017.

Time to Reevaluate Wellpoint

Wellpoint just released the company's Q2 earnings. The stock dropped a few percent right after the release. But the results seem fine to me and management upped its 2014 GAAP earnings guidance to $8.81. The stock drop tells me that the market has finally revalued Wellpoint and the entire managed care industry. Two years ago Wellpoint was trading at half of the current $110 price. That priced the company at less than 10 times trailing earnings. Joe Swedish has improved the company's operations and appears to be a very shareholder friendly CEO. Now it is trading at 13 times projected 2014 earnings. This is a multiple expansion is what I had hoped or expected when I last added to my position two years ago.

Now it is a half year after Obamacare's individual mandate and we have a better but still foggy picture of heathcare. This is a good time for me to reevaluate WLP.

Obamacare affects Americans not just through its individual mandate. But the individual mandate is the most controversial and far-reaching part of the legislation. From what I see so far, the uninsured aren't dragged kicked and screaming to get coverage. And the new enrolees aren't just the sick and unprofitable members of the pool. I can tell because the Obamacare first year enrolment exceeded projections. And as further evidence, the California Obamacare insurers plan to raise rates 4.2%, which is less than the healthcare industry overall. This means that the first year rates were adequate and the enrolment mix had enough healthy to cover the unprofitable sick. Remember, Obamacare cannot discriminate the sick from the healthy with different rates.

Another controversial part of Obamacare is the Medicaid expansion. Medicaid expansion under Obamacare raises the level at which a person qualifies for Medicaid. However, each state can opt out if they wish because of the 2012 Supreme Court ruling. So far about half of the states have opted out. However, the most populous of the 14 states where Wellpoint does business are participating in Medicaid expansion. And Medicaid enrolment is up 15% this year compared to last in participating states. Wellpoint should be well positioned with its recent Amerigroup acquisition.

Joe Swedish has been all gung ho on Obamacare since joining Wellpoint more than a year ago. Preliminary facts looks like it will pay off. The medical loss ratio (MLR) is now at 82.7%. The MLR is the ratio of benefits paid to revenue. It is one of the key metrics to measure medical insurance companies. It was at 85% before he took over. And the company bought back 8 million shares in the last quarter alone. Mr. Swedish seems to be really focused on improving the company's bottom line.

Wellpoint recently has been the cheapest of the MCOs because of missteps before Mr. Swedish arrived. But the valuation is catching up. The following table compares all the major MCOs.

	Wellpoint	Aetna	Humana	Cigna	Unitedhealth
Price	111	78.3	120	91.67	81.5
PE	12.6	12.0	16.0	12.6	14.7
ROE	0.10	0.16	0.12	0.18	0.16
P/BV	1.3	1.9	1.8	2.2	2.4
MLR	82.7%	83.1%	83.1%	84.5%	81.6%

Buying and selling stocks is a balancing act on a scale. In a perfectly efficient market the scale is balanced. I see possible future scenarios that would weigh in favour of holding WLP:

• Americans increasingly want health care, but are adamantly against government control. Obamacare increases in popularity.
• Healthcare has great pricing power, costs have been and will be rising significantly above GDP growth.
• Joe Swedish is the real deal, he will continue to improve the company's operations
• More Republican states accept Obamacare and actively participate (for example Medicaid expansion). 

But there are risks from possible negative scenarios that can also weight against holding WLP

• Obamacare enrollment falls to below expectations and causes the enrollment mix to be more skewed towards the sick.
• The president who takes office in 2017 is Republicans and he repeals Obamacare.
• Joe Swedish slips and is not as good as the media makes him out to be.

Overall though, I think the negatives are weak and unlikely. The market is still discounting for the uncertainty of Obamacare. The coming years will bring dramatic changes to medical delivery in the US. But still I feel market sentiment is ambivalent towards MCOs. It just isn't sexy. The market doesn't feel it is deep value, and it isn't growth. But who knows, maybe that will change soon. But the positive potentials of gradual but steady growth with all the changes is an opportunity that comes to an industry once in decades, and yet it is so discounted. If the positive scenarios take place as I hope, I think WLP can be $150. So I am keeping my WLP shares.

Portfolio Earnings Reports and Macro Musings

A slew of earnings reports have come in. I will summarize them in 60 seconds.

McRae Industries reported earnings that were flat compared to last year. But looking at last year's fantastic results, this is an accomplishment. If the company can show that last year was not an anomaly, then we have a new normal for this company. If so, I feel the company should trade around $40 instead of $30 now.

Wellpoint reported decent earnings. But the market pays more attention to the company's guidance because it is so committed to Obamacare. The company raised its 2014 earnings guidance from $8.20 to $8.50 per share. The new CEO Joe Swedish seemed to have aimed low with this guidance earlier and he is carefully managing the expectation upwards.

Wellpoint is spending considerable money to upgrade its IT systems for Obamacare. The company has already spent $550M. This leads me to believe that the company will have an advantage over other smaller competitors who do not have the scale to do such large upgrades. Wellpoint's success will be tied to Obamacare and the first year Obamacare enrollment numbers do not look so bad. People can slice it or dice it in many ways, but I think the Obamacare enrollment is as good as one could have expected a year ago. The bottom line is, people who don't have healthcare will buy it at a reasonable price.

I think the mainstream is starting to agree with me on this one. Barron's just published a bullish piece on Wellpoint. But I think when the mainstream starts to tout a company, watch out! The stock probably hasn't got much more room to run, and it is time to be contrarian on the stock. I definitely wouldn't add to my position, the only thing I will do in the future is selling.

Petsmart reported mixed first quarter results and they also lowered the year-end guidance. Same store sales this year will be flat compared to a year ago. The stock has tumbled 20% off its peak of a year ago. Today it trades at 14 times forward earnings. But here again, Barron has a positive piece on the company recently, which help the stock recover a bit. I wouldn't buy any more but I also don't want to sell because I dislike the capital gains tax.

In other news, Seaboard Corp completed their tender and announced that it was not fully subscribed. Therefore the buyback price will be $2950, which is the maximum price. I tendered about 15% of my shares.

And ITIC is down more than 20% since I started buying 5 months ago! And I don't really have an explanation for it. I have looked over the company a bit further to see if there is something about it that I missed in my initial analysis. I cannot find anything. Overall the housing market is stable and near-term should improve. The job market is improving which will do wonders for the housing market. Interest rates are up a bit but still near 12 month lows. So, in the absence of red flags, I have added to my position on the way down.

The US has seen inflation pick up to 2.1% yoy in May. Inflation directly affects interest rates and I'll be watching both closely. I own ITIC and four other insurance stocks. Insurance companies have large bond portfolios which would take writedowns if interest rates rise. But everything considered, inflation is a heck of a lot better than deflation.

Betting Against Headlines

We have reached just a momentous milestone. Yesterday was the deadline for Obamacare's individual mandate. As it stands, Obamacare enrollment met its 7 million original goal, despite a lot of heckling from its detractors. And possible more will be tallied in the coming weeks. However, it isn't clear to me what these numbers mean. It could consist of a lot people who lost their existing insurance plans and who turned to Obamacare. In any case, it looks like Obamacare is here to stay.

WLP, my largest holding, has invested more than any other MCO in Obamacare. WLP shares have broken over the $100 barrier recently. That is a 20% rise from just 2 months ago at least in part because Obamacare has turned out reasonably well at this critical juncture,

As I have said before. Obamacare is huge and unprecedented, so it is almost impossible to predict. And I don't try. I just took the bet for WLP and Obamacare because I felt the market was overreacting. Every little glitch or complaint seemed to be magnified by the media. If I was wrong I don't think I would lose much. But if I turned out right like it now appears, I could make some good money. This is an asymmetric bet.

Also, Obamacare became law because Obama shoved his plan down the Republican's throats — not a single Republican voted for it in Congress. He needs all the cooperation from the people and the MCOs. I don't think of insurance companies under Obamacare as a traditional regulated industry. Obamacare is asking the MCO's to take on the risks but the government will backstop the MCO losses. Each MCO can freely enter the market in whichever state it chooses. US healthcare cannot work well if the MCOs are hobbled by the government.

As I described in 2012 when WLP was low, every year or two some crisis appears in the headlines that takes some stock to attractive lows. That's when I try to be brave and buy. This year the headline victim is Russia. As we all know, Ukraine had some political turmoil that forced out a pro-Russian leader. Russia's Putin then used the situation as a pretext for annexing the Crimea, which before the crisis was a part of Ukraine, but which 60 years ago was part of Russia.

I then read that the crisis has caused the entire Russia stock market to trade at about 5 times earnings! So I decided, based on my best estimate of the geopolitical situations and Putin's intentions, to make a bet on Russia. I bought some ERUS, the iShares' Russian ETF. As it has so far turned out, the situation has calmed down and it appears Putin has no more territorial ambitions. It also appears that the West is going to let Russia get away with it. I hope that the Russian market will return to the highs of 2013. If that happens I can make a 40% profit. I don't expect this to happen overnight. I expect it to take a year or two if it happens.

WLP Sells Division

Wellpoint has announce that it will divest its eyeglass business in order to focus on its core business. The company said that this will cause an approximately $0.55 charge in the coming quarter.

So, Obamacare has begun and we have 2.1 million people enrolled. The initial goal is 7 million by the March deadline for enrolling without incurring a penalty. I think worse case is 4 million and if it is significantly above that I expect WLP will easily hit new highs.

So I'd like to, once again, summarize my thesis for WLP serving Obamacare.

1. Obamacare does not socialize or nationalize health care
2. The public, the politicians for Obamacare and the politicians against Obamacare are all either neutral or very sympathetic to insurance companies who are simply caught in the middle of this issue.
3. Obamacare is adding 7 million to the insured pool. Insurance companies like WLP know the risks and are voluntarily going in with their eyes wide open
4. I feel Obamacare is part of an overall consumer trend towards more "luxuries" as our standard of living rises.

In other news about my portfolio, I have closed my KCLI position. I feel Kansis City Life is a well-run company with minimal exposure to risky annuities. However, it has run up along with the rest of the stockmarket, and the price is now 75% of book. Still, if the market corrects and KCLI drops, I will certainly consider buying.

Wellpoint and Obamacare Today

The White House announced today that the Affordable Care Act (aka Obamacare) would extend the deadline for medium to large companies to provide health insurance by one year; from Jan 2014 to Jan 2015.

This is an interesting development but I believe the Obamacare is proceeding mostly as planned. I have followed Obamacare closely because Wellpoint (WLP) is my biggest holding. The stock has run up 50% since the lows of last year. So, this stock is becoming an ever larger portion of my portfolio.

WLP is the managed care organization (MCO) with the largest number of individual subscribers. And Obamacare will have the biggest effect on uninsured individuals. The individual mandate will take affect Jan 1, 2014. As that day approaches, I pay more and more attention to WLP.

Coming in 2014, each state will offer an exchange for individuals to choose health insurance offered by private MCOs like WLP. I think the exchanges are ready for 2014 and will not be delayed like the company mandate. Parts of Obamacare have been in force since 2010, but the individual mandate is the most significant part of Obamacare for WLP because WLP is a large provider of individual insurance. And the mandate was challenged all the way the supreme court, but it survived. The individual mandate means an additional 30 million Americans who otherwise don't have insurance must either now go to an exchange to get one, or pay a penalty tax.

I see two big possible risks to WLP in the coming year. The first is fear of government oversight of the managed care industry which would restrict profits. One part of Obamacare dictates that the portion of premiums that at least 85% of premiums must go back to pay for costs (this is called the medical loss ratio). This law reminds me of the government's taxation of tobacco companies to pay for health problems resulting from smoking. The resulting effect of that law is actually greater market share by the dominate tobacco companies. This part of Obamacare, like other government regulation of businesses, will fatten the big dominant companies (like WLP) at the expense of the smaller ones, because of their greater scale.

The second is the possibility of losses from serving sick individuals who previously don't have health coverage. WLP voluntarily participates in the exchange system because it relies on individual customers for a large portion of its business. This is a known issue and WLP, like all participants, enter exchanges with their eyes wide open. They should be able to judge the risks and begin conservatively. Also, the biggest positive is that the government designed the individual mandate to spread out the risk by forcibly adding a previously uninsured pool of 30 million people.

Getting a Bigger Piece of the Pie

When I invest I like to think contrarian and not overweight headlines. With MCO companies the statistics and information about demographics and costs can be overwhelming. I think the market tends to get too caught up in the numbers while failing to look at the big picture. The bottom line is the US spends 17% of GDP on healthcare. And much of that 17% goes through MCOs. The following illustrates the coverage of all people in the US. As one can see 69% of people are covered by MCO. About 16% are uninsured, and time will tell how much of this 16% will participate under Obamacare, maybe 8%? maybe 10%. The other 15% are various government agencies such as Medicare and Medicaid. But both of those have private MCO options. At the time the chart was made, in 2010, 12 million people use Medicare through MCOs, by 2015, it is projected to be 16 million. So the MCOs are eating into the government's piece of the pie, and the government is ok with it! In any other industry where the market is growing by millions of customers per year, the market would drool. But, it doesn't seem so with managed care.

 

Health Coverage for all US Persons

Why I Still Own WLP

Wellpoint reported earnings of $2.94 for the first quarter 2013. This is an excellent start for the new CEO Joe Swedish. If we project this earnings to a full year, it is a P/E of about 6! However, for some reason, WLP projects earnings to be $7.75 only. I am not sure why. The company did say integration costs of Amerigroup will be a drag on earnings. Still at a current price of about $73 per share, WLP is compelling.

WLP is a managed care company. The company has the Blue Cross/Blue Shield license in 14 states. Late last year, the company agreed to buy Amerigroup, a Medicaid manager, for $4.9B.

Last year I was bullish on WLP because it suffered from several big headline events. First was Obamacare's victory in the Supreme Court. Most had expected the mostly Republican Supreme Court to strike down Obamacare. Second was disappointing earnings for Q2 2012. Shortly after that, then CEO Angela Braly left. The following chart shows these events' affect on the share price. WLP was normally a stock with a P/E less than 10, and then in Fall of 2012 it drops more than 33% following two events.

Shortly after these events, WLP issued more debt and bought back more stock. That is a great idea. The company get debt at around 2.75% interest and get stock that yields 15%. In addition, WLP bought Amerigroup. And last quarter earnings shows that WLP at the moment is a cash cow.

Still the biggest overhang on the business is Obamacare. In October, as part of Obamacare, all states will implement exchanges. Exchanges are government run marketplaces where individuals and business can go to compare policies and premiums. Note that all this does not necessarily mean that the government will compete with managed care companies like WLP. In fact based on what I understand of government and healthcare, the government likes to outsource management. For example, more than 70% of all Medicaid enrollees use managed care companies like Amerigroup. With the expansion of Medicaid and insurance coverage overall, managed care companies now have 30 million more potential customers.

The flip side is fear of government regulation. Right now, government restricts benefit expense ratios to be 85% or less. Wellpoint's ratio is 86%. So it is within reasonable limits.

I am purposely being vague in my analysis of the Obamacare situation, because Obamacare is a confusing topic. It affects almost everyone in America yet I don't think the majority knows how it will affect them come October. How it will play out is very unclear, regardless of whether you are a lobbyist, politician, doctor or a WLP executive, we are all pretty much in the dark. But, to me, managed care companies have tremendous potential and WLP in particular has a huge margin of safety.

In my post last year, I listed some negative headline events that unnecessarily depressed decent large cap stocks. I participated in some of these events, namely Philip Morris. Now, the future will tell if Wellpoint is another. If it is, then I believe the WLP bears will capitulate when the dust begins to settle on Obamacare. That could take two to three years. By that time, who knows, WLP could double.

MSFT and WLP Quarterly Update

Happy New Year!

2012 was a good year for the US market overall. And I have a good feeling about 2013.

I'll start the year by summarizing quarterly results from two of my largest holdings: Microsoft (MSFT) and Wellpoint's (WLP).

MSFT earned $0.76 a share versus $0.79 a year ago. The company did post record revenue of $21.5B. But some of that was the effect of deferred recognition of Windows 8 revenue. If we average out the last two quarter to nullify this effect, the revenue is $37.5B for the last six months versus $38.3B a year ago. So Windows 8 is not giving a big enough boost to MSFT. In fact, Windows sales is down for the six months compared to last year. Along with lackluster sales is increased marketing costs associated Windows 8. Still, I rate MSFT earnings as decent because this is a slow year for computer sales.

And I said in my earlier MSFT post, I don't expect great things from the company. I only expect them to hold ground against competitors like Apple in OS and mobile device makers running on Android or Apple's IOS. And right now I see MSFT doing just that, and my sentiment now is hold.

Wellpoint (WLP) earned $8.18 per share for the 2012 year, which was slightly better than consensus. This earnings was with certain special items. Without that earnings was $7.56. I feel this is great for a stock trading at $66 but fantastic when it was at $53 just a few months ago. I am not surprised that it is at $66 today. I stated my positives views on WLP in an earlier post. At that time, Obama wasn't yet re-elected and therefore Obamacare wasn't certain to stay. With Obama subsequently elected, WLP did drop about 10%. But now, that keen-jerk has reversed itself.

I feel both MSFT and WLP are solid large cap stocks. Their valuations will be fundamentally correlated to the US market overall, but they also have a undervalued bent. So I expect them to beat the US market overall with little risk.

Any other holders of these two companies out there? Please let me know your comments.

Quarterly Update: WLP, Cisco and JOE

Wellpoint (WLP) announced they earned $2.15 per share, including investment gains, versus $1.90 in the same quarter last year. They lost 2% membership in the last quarter. And WLP has a high medical expense ratio at 85%. All this needs to improve under the yet to be named new CEO.

WLP is my second largest holding and I wouldn't start selling any shares until it goes over $70. And then I would only sell to have a smaller exposure, not because I am trading the stock or that I don't believe in it.

Cisco announced they earned $0.39 per share. That is an 18% increase over the same quarter last year. Their overall revenue increased 6%. Cisco paid $0.14 in dividends. At the moment before the announcement the stock traded at $16.80. But this news was definite surprise as the stock has since jumped 10%. I have had Cisco for over a decade. I have recently wanted to close this position, but as I mentioned in a previous post, the valuation always draws me back. I have bought the stock many times when it was very undervalued, and then sold after a 10-20% gain. The idea is to reduce the exposure when the stock goes up, until zero if the share price is high enough. I don't want Cisco to be a long term investment anymore because I generally do not like technology. Technology is just too unpredictable. I cannot do a basic analysis of the financials and make a high probability bet on a good return. But Cisco right now is simply too undervalued. They have over $10 per share in cash and short term investments. They are increasing revenues and earnings.

As far as I can tell, Cisco is so undervalued because it is no longer in vogue. Their story is they sell the backbone of the internet to the world. They have done this very well for the last decade. But the stock has declined to 1/4 of its high, because that story is old. The market wants to hear about things like personal devices, the cloud and emerging technologies. I want Cisco to chase those only if they can give back a good return on investment. Short of that, I prefer Cisco to buy back shares and keep dominating the backbone. I don't think the market gives Cisco enough credit for still being in the same position as it did during it's heyday; i.e., owning 3/4 of the router market. But one day, something will happen that will make the market perceive that Cisco is hot again, something like a sea change in opinion like with cigarette companies in the last 10 years.

St. Joe (JOE) announced quarterly earnings that was very well received by the market. The company simply eked out a small profit and that was enough. I read they sold some non-strategic land for $5655 per acre. That gives me an idea of the prices they would fetch for their lower end land right now. Given that they have over 500,000 acres, their book value appears to be more than the market cap of about $2 billion. As I said in a previous article, JOE is a simple play on land for me. I bet Berkowitz, who is chairman of the board, can stem the drop in the stock price and turn the company around. So far it is working.

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

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Disclosure: I own KFT and PM.