The Health Care M&A Monthly: WellPoint Buys RightChoice Managed Care For $1.3 Billion

Does the largest health care transaction of the month signal a renaissance in the Managed Care M&A market, or is it just a fluke? In late October, WellPoint Health Networks, Inc. (NYSE: WLP) announced that it would acquire RightChoice Managed Care, Inc. (NYSE: RIT) for $1.3 billion.
Based in Thousand Oaks, California, WellPoint Health Networks is the parent of the California Blues, and the first Blues plan to go public. Since then, it has expanded into other markets targeting additional Blues plans and other health care insurers. It currently has HMO operations outside its native California in Georgia, Illinois and Massachusetts.
In terms of membership, WLP currently provides health benefits to 10 million medical and 44.3 million specialty members through Blue Cross of California, Blue Cross and Blue Shield of Georgia and UNICARE, as well as its more modest Illinois and Massachusetts operations. Based on the nine months ended September 30, 2001, WLP generates annualized revenue of $12 billion, EBITDA of $860 million and net income of $406 million. Its current market cap is about $7.25 billion.
RightChoice Managed Care is the largest provider of managed health care benefits in Missouri. It has 2.8 million members, which includes workers’ comp and self-funded members. It is the parent of another Blues plan, Blue Cross and Blue Shield of Missouri, which includes approximately 160,000 medical members. Based on the nine months ended September 30, 2001, RIT generates annualized revenue of $1.2 billion and income of $66 million. Those figures are up from previous levels due, in part, to RIT’s increased concentration on its PPO products.
WLP is offering to pay $66 per share in cash or exchange 0.6161 shares of WLP common stock for each share of RIT common. Thanks to a prorationing mechanism, WLP will end up paying for 70% of this deal in stock with the remaining 30% in cash. With 19.6 million shares outstanding, the purchase price calculates to $1.3 billion, which works out to approximately $460 per member or 1.08x revenue.
In many respects, RightChoice has been building toward this deal for years. Aside from gaining the ability to raise capital in the public equity markets, the ability to acquire and be acquired was one of the primary rationales for the company to convert from a nonprofit to a publicly traded company. As with many other conversions, the transformation of nonprofit Blue Cross and Blue Shield of Missouri into for-profit RightChoice was a long and complicated ordeal, some details of which have already been chronicled in this newsletter. Along the way, RIT, which began life as a subsidiary of the Missouri Blues, made some small acquisitions of its own, details of which appear in our databases. The final, crowning step in the conversion process occurred one year ago in November 2000 when RIT finally acquired Blue Cross and Blue Shield of Missouri, along with its membership and valuable trademarks, for $187.8 million.
As a condition of that transaction, the Missouri Foundation for Health (MFH) was created which owned 80.2% of the equity of the combined organization, but was required to reduce that holding to 20% over the next five to seven years. It currently owns 11.1 million shares of RIT common stock, or 57% of the shares outstanding.
For the current deal to go through, therefore, MFH must give its approval; and they have indeed agreed to vote their shares in favor of the transaction. After all is said and done, MFH will add $733 million to their coffers, giving themselves a total of $900 million. And, given the public’s current animus towards managed care organizations, they may well have reasoned that it would be some time before they got a better offer.
Industry insiders had always regarded RIT as a prime acquisition target by another Blues plan. It had been occasionally suggested in this column that Chicago-based Health Care Services Corporation, the parent of the Illinois and Texas Blues, might be interested in RIT, but its status as a mutual legal reserve company limits its ability to raise the capital. Anthem (NYSE: ATH) would have been another potential buyer, but had recently focused its attention on its IPO. Timing, as they say, is everything.
The markets approved of this deal. WLP’s proposal offered RIT shareholders a 46% premium over the $45.10 price at which the stock was trading the day before the announcement. Since then, however, RIT’s stock price has shot up and now trades in the $66 to $68 range, eradicating the premium. Although WLP stock suffered a small, 5% drop in price on news of the announcement, slumping from $107.10 to $101.50 per share, it quickly rose again to trade in the range of $111 to $114.
This deal will give WLP just over $13 billion in annual revenue and 12.8 million medical members. While the purchase price is slightly higher than might be expected in today’s market, it does two things for WLP. First, it makes WLP the fourth largest health care insurer in the country. Second, it allows WLP to strengthen its operations in the Midwest, where last year it acquired the Rush Prudential Health Plans in Chicago with its 300,000 members for $202.6 million. That deal added to WLP's UNICARE Life and Health Insurance Company operations in Illinois, with 283,000 medical members in Illinois and a provider network of approximately 10,600 physicians and 117 hospitals. Even so, the RightChoice deal will significantly shore up WLP’s Midwestern operations.
That WLP has wanted to expand is no secret. It recently acquired Cerulean Companies, the parent of the Georgia Blues. Although the Georgia Department of Insurance finally approved this $700 million deal in March 2001, WLP had been working towards this goal since July 1998. The price paid there was just under $420 per member, and just under 0.60x revenue.
Is this deal a harbinger for renewed M&A activity in the Managed Care sector? After all, the deal comes at roughly the same time that Anthem and Amerigroup (NASDAQ: AMGP) completed their IPOs.
Further, the media is reporting that two other Blues plans, CareFirst BlueCross BlueShield, which operates in Maryland, Delaware and the District of Columbia, and Blue Cross and Blue Shield of North Carolina, are also dipping their toes in the conversion waters. It is much more likely, however, that these plans, as well as the Wisconsin Blues, which recently converted to a publicly traded corporation, eerily shadowing RIT’s conversion process, would themselves become acquisition targets by the likes of an Anthem or a WellPoint.
However, investors will remain chary about putting their money in the Managed Care sector in the near term to be used for acquisitions or other purposes. Two years of double-digit premium increases have done little to allay the general public’s distrust of the industry. Nor, would it seem, have those increases done much to buoy managed care companies’ finances. Our largest managed care company, Aetna (NYSE: AET), lost $54.4 million in the third quarter. According to a recent industry report, for the past seven years, HMOs have been losing money on average, not the sort of picture calculated to attract investors. Once we have a better idea, early next year, of how managed care companies are operating and how premium increases are working out, we will be better able to say whether the Managed Care sector will attract enough investment capital to sustain a robust acquisition market.