UnitedHealth 2Q Profit Falls 51%, But Don’t be Misled by the Merger Mania and What UNH Stands to Gain

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UnitedHealth Group Inc. (Minnetonka MN) posted strong earnings for its latest quarter as revenue continued to surge in its pharmacy-services business. The company, which is the biggest U.S. health insurer, also gave a slightly brighter full-year outlook, said the Wall Street Journal.

But despite the generally positive news, there was one major problem area: Affordable Care Act plans, which UnitedHealth will almost completely stop selling next year.

The insurer booked another $200 million in full-year ACA-plan losses in the second quarter, bringing its projected total loss for the year to about $850 million. About $245 million of that was included in 2015 results and $605 million this year.

ACA-plan enrollments were larger than expected, including more limited erosion. Also, costs mounted because enrollees were even sicker than projected, with more chronic conditions than last year, including AIDS, hepatitis C, diabetes and chronic obstructive pulmonary disease.

Stephen J. Hemsley, UnitedHealth’s CEO, said that despite the ACA business, medical-cost trends remained “well-controlled and consistent with expectations,” a comment likely meant to reassure investors worried about a potential uptick in health spending.

Company officials said the inpatient hospital admissions rate was lower than last year but flagged a few areas where costs had picked up, including specialty pharmacy and emergency-room use.

The insurer’s medical-loss ratio–the percentage of premiums paid in claims–edged up to 82%, lifted by results for its ACA plans. UnitedHealth’s health-services unit Optum continued to show strength, with revenue there jumping 51% to $20.6 billion, representing about 44% of the company’s top line.

The business has been buoyed by UnitedHealth’s acquisition of pharmacy-benefit manager Catamaran Corp., which closed last July. Its profit for the quarter was $1.75 billion, or $1.81 a share, up from $1.59 billion, or $1.64 a share, a year earlier.

Excluding certain items, adjusted per-share earnings rose to $1.96 from $1.73. Revenue climbed 28% to $46.49 billion. For the full year, the company now expects adjusted earnings of $7.80 to $7.95 a share; its previous forecast was $7.75 to $7.95 a share.

Analysts had projected adjusted earnings of $1.89 a share on revenue of $45.05 billion. The company’s shares, which have gained 20% this year, closed the week off 49 cents at $143.20.

Steve’s Take: The DOJ’s decision to attempt to block the mergers of Anthem/CIGNA and Aetna/Humana has overshadowed media coverage of what might happen to UnitedHealth if both mergers are approved.

Yes, consolidation of four of the five largest health insurers in the U.S. will shrink that number from 5 to 3. But in the process of such consolidation, if it occurs, it’s unlikely to jeopardize UnitedHealth’s position at the top of the industry, according to Moody’s Investors Service. I believe UNH will actually strengthen its stranglehold on the No. 1 spot. Here’s why.

UnitedHealth’s diverse portfolio business lines, consistent financial performance and brand recognition should help ensure it retains its competitive edge as rivals Anthem and Aetna each seek to grow their market share, Moody’s analysts wrote in a recent report:

“Despite the recent flurry of activity by its competitors, UnitedHealth will remain one of the largest, most diverse, and financially strong U.S. health insurance companies, serving nearly 48 million members in all of its major segments.”

If Anthem completes its acquisition of CIGNA, the resulting combined company would overtake UnitedHealth as the largest publicly traded U.S. health insurer by total membership, serving approximately 54.9 million members.

However, UnitedHealth would remain the country’s largest health insurer by total revenue, having garnered more than $91 billion in revenue through the first half of 2016, compared with the estimated 61.5 billion that a combined Anthem/CIGNA generated.

“From a financial metrics standpoint, UnitedHealth is projected to be stronger than either post-merger Anthem and Aetna, with higher revenues, earnings, cash flow, and lower debt obligations, along with better leverage ratios,” according to the Moody’s report. UnitedHealth may also be able to capitalize on potential regulatory asset divestitures (policies) required by the DOJ as a result of the two large mergers,” Moody’s added, suggesting UnitedHealth could grab Anthem/Aetna’s forced spinoffs.

Both of the proposed merger deals were announced almost simultaneously last summer because none of these players wanted to be left without a major partner. Going it alone would mean operating at a disadvantage to larger arrivals, including UnitedHealth.

The pressure on Anthem/CIGNA to wrap up a deal and build negotiating leverage in a rapidly consolidating healthcare industry will get amplified if their merger is sidelined and Aetna/Humana goes through.

I can picture you, Stephen Hemsley, UnitedHealth CEO, quietly biding your time amidst all the hullabaloo about the pending Anthem/Aetna mergers, while licking your chops at the pre- and post-merger asset opportunities you can likely capitalize on at fire-sale prices.