Health and Healthcare

Why the Market Is Punishing Centene Over Its Planned WellCare Health Plans Acquisition

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Investors frequently win when they invest in a company that is being acquired, and sometimes they even get a bump in owning shares of the company acquisition. And some mergers get a reaction that is negative enough that the teams in management might have fallen on their faces.

Centene Corp. (NYSE: CNC) was down handily after making roughly a $17 billion all-in acquisition offer to acquire WellCare Health Plans Inc. (NYSE: WCG). The value of that acquisition is above $15 billion in the cash and stock offer plus the debt, and Centene is effectively targeting a larger effort around its government-backed Medicare and Medicaid businesses and trying to lower its exposure to the Obamacare health exchanges.

The original $305 (rounded) offer would have been a 32% premium to WellCare’s prior close of $231.27, but WellCare shares were last seen up only 9.2% at $252.58 due to the 8.1% drop to $50.35 in Centene’s stock price.

WellCare’s shareholders are targeted to receive 3.38 Centene shares per WellCare share, plus $120 per share in cash. That brings WellCare’s ownership of the combined company representation to about 29%.

The merger is targeting around $500 million in cost savings from the deal in the second year after it closes, and the combination was projected to be accretive to earnings in the mid-single digits in year two. WellCare had operating expenses of $19.16 billion in all of 2018, but $1.67 billion was counted as its general and administrative costs. Centene’s selling general and administrative costs were $6.33 billion in 2018, versus total operating expenses of $54.55 billion. Wednesday’s release also projected that the combined enterprise would have an estimated pro forma 2019 revenues of about $97 billion with $5 billion in EBITDA.

This latest merger strategy is on the heels of the Trump administration’s increased opposition against President Obama’s health care law. While the legal fights continue, a recent U.S. Department of Justice stance has been that Obamacare is a violation of the U.S. Constitution and should be struck down.

It is no secret that health care mergers have been on the rise. CVS and Aetna merged in a $69 billion deal in 2018, and there was a $52 billion deal between Express Scripts and Cigna. The ongoing issues around these mergers are companies trying to limit exposure to future regulations, reimbursement pressure and risks around changes to Obamacare.

Roughly 40% of Centene’s earnings are tied to the Obamacare business, and that would make it among the most vulnerable providers if the law is overturned.

The combined Centene-WellCare (newco) would have roughly 22 million members and would have a presence in all 50 states. Centene had roughly 8 million members on its own as of the end of 2018.

The combined company will have a about 11 million lives covered over 22 states in the Medicaid business. There are some states where there will be overlaps in the Medicaid business, so it remains to be seen how regulators will treat the combination on that level. Centene’s CEO Michael Neidorff will preside as the chief executive of the combined companies.

There is another risk that investors see here with the merger not expected to close until the first half of 2020. That could mean more than a year of transition times, and it also will be right as the election cycle begins to enter its hyperactive phase.

The companies want to see their big gains continue ahead. Over the past five years, Centene’s shares had risen more than 250% and WellCare shares had risen about 225% around the growth of the exchanges. The companies are targeting roughly $500 million in cost synergies in the second year after the merger closes.

Investors historically have been large fans of mergers in the health care space. And there is supposed to be a theory that the larger a company gets its chances of survival and prospering rise. This is one of those mergers that is not getting the warm fuzzy feeling that management teams love to see.

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