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Health Care: Obamacare M&A Trumps Weak Earnings Outlook

"Expect other companies with government exposure to see greater investor interest," wrote Credit Suisse analyst Charles Boorady in a July note to clients, highlighting Centene, Molina Healthcare, Humana (HUM - Get Report), Coventry Healthcare (CVH) and Health Net (HNT) as other healthcare providers with high Medicaid and Medicare exposure.

Also in early July, Goldman Sachs analysts raised their price targets for Centene and Molina Healthcare, citing the likelihood of healthcare sector consolidation. "[We] see further consolidation likely following the announcement of WellPoint's proposed acquisition of Amerigroup, which reflects the push by the larger 'diversified' managed care names to broaden exposure to public sector managed care growth opportunities," wrote analyst Matthew Borsch in a July 11 note to clients, which upped Molina's price target 8% to $29 and Centene's by 12% to $39.

The court confirmed the Act's ability to force Americans to carry health insurance and compel insurers to cover people with pre-existing health conditions. It limited the extension of Medicaid, however, deeming it unconstitutional for the federal government to withhold money from states that don't comply with the Act. Some estimate that between 16 million to 20 million new Americans would be eligible to enroll in Medicaid through the Affordable Care Act.

While Medicaid players may be takeover targets, large scale merger efforts may be less likely after a generation of consolidation among healthcare giants. "We continue to assign a low probability ranking to UnitedHealth, WellPoint, and Aetna, as we think these companies are too large to merge with one another, owing to antitrust limits, among other factors, while we think an acquisition of one of these 'Big 3' by a company outside of managed care is also unlikely," Borsch said.

The M&A speculation comes amid a cloudy health care earnings profile. In the first quarter, diversified healthcare providers like Humana and Aetna and Medicaid-focused providers missed earnings per share estimates. Second quarter earnings concerns from Wall Street analysts center on how high loss ratios could go now that providers are mandated to accept customers with pre-existing medical conditions.

"WellPoint's announcement provided a welcome 'change of topic' from the post-SCOTUS ruling gloom in the managed care sector. However, our broader outlook remains mixed and we maintain our Neutral coverage view," noted Borsh of second quarter earnings expectations. "Beyond 2012, the longer-term growth story remains attractive, in our view, particularly at these valuations."
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