Jenks Healthcare Business Report November 2001

In the November 2001 issue:

IPO Market Open For Health Care Business - Finally

As the markets get back to normal, the IPO market burst with activity. Five new health care IPOs were priced, and all have traded above their offering levels. More new issues can be expected before the end of the year.
P. 1

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The Venture Capital Market

The future IPO candidates continue to attract private venture money, with 16 companies raising more than $300 million in the past month.
P. 8

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New HMO Survey

Milliman USA’s 10th annual survey of HMOs reports that average premium increases of 16% can be expected in 2002, on top of the 12% to 18% jump last year. Have these increases been healthy for the payers?
P. 10

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Cancer Care

Coming up with cures to fight cancer has been big business, but the battle is far from over and companies, large and small, continue to develop new therapies.
P. 12

Jenks Healthcare Business Report

IPO Market Open For Health Care Business - Finally

In early October, when Given Imaging Ltd. (NASDAQ: GIVN) ended the seven-week IPO drought, underwriters, investors and senior management at other health care IPO wannabes held their collective breath to see if it would hold. Although initially GIVN’s IPO did trade above the offering price of $12 per share, it traded as low as $7.20 per share only to rebound to $11.31. Not a stellar performance, but no one is complaining given the overall market uncertainty at the time.

Following in its footsteps just nine days later was another medical device company, Therasense (NASDAQ: THER). As the market strengthened and investor demand for IPOs increased, after market performance improved. THER opened above its IPO price of $19 per share and has never looked back. Currently, the stock is up 27% since its October 12 launch. A sense of renewed confidence began to seep into the market, at least for health care issues, and the stage was set for the late October and early November batch of five IPO pricings.

Although it was the second health care IPO in this latest grouping, Anthem’s (NYSE: ATH) was the largest and most successful of the five. The health insurer had originally expected to sell 28.6 million shares at a range of $33 per share to $37 per share. The Friday before pricing, the lead underwriter, Goldman Sachs, increased the size of the offering by 11.4 million shares, and then added another 8 million shares the day of the pricing. Demand was so strong that the IPO opened 12.5% above the $36 per share offering price, and currently is trading at a 27% premium. Anthem’s was the sixth largest IPO this year and the second larger than $1 billion since September 11. The company now has a market capitalization of $4.6 billion. Not bad for a group of stodgy old Blue Cross/Blue Shield plans.

The origins of the company go back to 1944 under the name Mutual Hospital Insurance, commonly known as Blue Cross of Indiana. In 1985, it merged with Blue Shield of Indiana under the name Associated Insurance Companies, Inc. In 1993, Blue Cross and Blue Shield of Kentucky came into the fold, and in 1995 Ohio-based Community Blue Cross and Blue Shield was merged into the company, with a name change to Anthem Insurance Companies the following year.

With a strong foothold in the Midwest, Anthem next targeted New England and in 1997 purchased Blue Cross & Blue Shield of Connecticut. In late October 1999, the company completed the purchase of Blue Cross Blue Shield of New Hampshire for $125.4 million, or $344 per enrollee, followed one month later by the $160.7 million ($338 per enrollee) acquisition of Blue Cross and Blue Shield of Colorado and Blue Cross and Blue Shield of Nevada, representing a new region. Last year, operations expanded in the Northeast with the $92.6 million ($196 per enrollee) purchase of Blue Cross and Blue Shield of Maine. Finally, last May Anthem entered into an agreement to buy Blue Cross and Blue Shield of Kansas for $190.0 million ($266 per enrollee), which will add more than $1.0 billion in annual revenues.

In early 2001, management decided it was time to "demutualize" the company and convert to a publicly traded stock company. The plan was approved by the board of directors in June, setting the stage for the IPO. Of the total net proceeds in excess of $1.5 billion, approximately $837 million will be used to pay those eligible members (policy-holders) who elected to receive cash instead of shares in connection with the conversion. In other words, prior to the increase in the size of the offering, there was not going to be much left over for company use. Now, Anthem will have almost $700 million for working capital and, more importantly, acquisitions, but we expect some of the unexpected additional funds will go towards reducing the company’s almost $600 million of debt.

Anthem has been profitable in each of the last five years, and operating revenues for the six months ended June 30, 2001 were $5.0 billion with a net income of $143.0 million. The company has the leading market position in seven of the eight states it operates in, an unusually consistent market penetration for any company. Anthem is now the country’s fifth largest health insurer, and as of June 30, 2001 it had 7.8 million members, 62% of which are in the Midwest with 28% in New England. The company has only 101,000 Medicare + Choice members and an equal number of Medicaid members, which investors should like. The company’s medical loss ratio has also been consistent at approximately 85% over the years. As the health insurance market consolidates, Anthem is well positioned to continue as one of the consolidators.

Trying to piggy-back on the success of the Anthem IPO, another health insurer, Amerigroup (NASDAQ: AMGP), priced its 4.4 million share IPO on November 5 at $17 per share, which was the low end of the estimated range. Although profitable, with net income of $17.1 million on revenue of $395 million for the six months ended June 30, 2001, the company focuses on serving customers dependent on various state health care programs, including Medicaid and the Children’s Health insurance Program (CHIP). The Virginia Beach, Virginia-based company originally filed its IPO registration statement 19 months ago, but its increasing profitability since then probably helped it finally get priced. The stock price has hit a high of $22.55 per share, but is now trading at an 8% premium to the offering price. The lead underwriters were Banc of America Securities and UBS Warburg.

Kicking off the health care IPO surge in the past month was a hospital staffing company called Cross Country Inc. (NASDAQ: CCRN). Led by Merrill Lynch, the company sold 7.8 million shares at $17 per share, which was the top end of the estimated range. It opened at almost a 20% premium and is currently trading at a 40% premium after hitting a high of $26.30 per share. In 2000, the company made $4.6 million on $367.7 million in revenue, but it is experiencing double-digit growth this year. Almost 80% of its revenue comes from supplying hospitals with nurses on a temporary basis. Although this is very costly to any health care provider, the shortage of nurses and other health care professionals has required the use of temporary staffing. As the economy weakens, however, it is unclear whether the ranks of health care providers, such as nurses, will begin to increase as unemployment lines swell. Some nursing home chains are already seeing a drop in temporary staff usage, and since hospitals are seen as the top of the health care food chain, more nurses may seek permanent employment at these sites.

An even larger offering, and coming almost three weeks after Cross Country’s successful debut, was the IPO for AMN Healthcare (NYSE: AHS), another hospital staffing company. The 10 million share IPO, led by Banc America Securities, was priced at $17 per share, which was above the estimated range of $14 to $16 per share. It jumped 20% the first day of trading as is currently up 27%. Obviously, this offering benefited from the success of Cross Country’s IPO. AMN Healthcare had net earnings of $4.6 million on revenues of $357.1 million for the first nine months this year. Revenues have grown at almost twice the rate of last year. Although both companies are successful, and profitable, what is a little unsettling is the high PE ratio of the two. AMN, for example, with a market cap of almost $900 million, is trading at almost two times revenues and a huge multiple of earnings. What investors need to remember is that the assets of staffing companies can walk out the door at any time, for any reason.

Finally, the first health care provider in many months, Odyssey HealthCare (NASDAQ: ODSY), completed its IPO. Led by Merrill Lynch, the 3.6 million share offering came out at $15 per share, which was the top end of the estimated range. The IPO opened above its offering price and currently trades at a 16% premium. The proceeds will be used to pay off the company’s line of credit and its senior subordinated notes.

Odyssey is one of the largest providers of hospice care in the country, with locations stretching from California to Pennsylvania. Formed in 1996, it now has 38 hospice locations in 21 states with an average daily census of 3,320 patients, or 87 patients per location. Net revenues for the six months ended June 30, 2001 were $57.0 million and the company earned $4.3 million. The company completed 10 acquisitions in 1998, a few more in 1999 and 2000, and four deals so far in 2001. The company has received outside venture capital funding from five firms, including Weiss Peck & Greer and Three Arch Partners.

One of the drivers for the growth of the hospice business in general has been the role of government payers. In 1998, Medicare paid only $118 million for hospice care, but by 2000 this number had increased by $2.9 billion. Part of the reason for the increase is that the number of Medicare beneficiaries electing hospice care has tripled during that time period, but costs have also risen. Odyssey receives more than 95% of its revenue from Medicare and Medicaid, so it is obviously at risk for changes in reimbursement methodology. Hospice care, however, is usually cheaper than nursing home care and always cheaper than hospital care, so the government payers may not be applying much pressure any time soon. As far as growth is concerned, the demand for hospice care will do nothing but increase for the next 40 years.

The success of these IPOs may be crucial for many sectors of health care over the next few years. Capital is needed, especially for those companies emerging from bankruptcy protection that want to grow again. Equity capital is especially important in those sectors that have seen a shrinking supply of debt available to them. If investor demand for health care services IPOs continues to gain strength, senior care, home health and rehab companies may be lining up in 2002. These will not be huge companies, but will include those with a strong regional market penetration and, of course, a recent history of profits. No more promises; investors want proof of success today.

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