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Aetna's Coventry Deal Signals 'Obamacare' Consolidation

As investors position on the Supreme Court's landmark health care decision, they may be wise to spend their time understanding how consistent M&A trends are already consolidating the health care sector, an industry shake up confirmed by Aetna and WellPoint's multi-billion dollar deals.

Already, some companies have used recent mergers to position themselves for key earnings opportunities, amid the prospect that profit margins fall throughout the healthcare sector.

"There is a very basic level of consolidation that is taking place," said Marc Cabrera, head of the health care investment banking practice at Morgan Joseph TriArtisan, of widespread health care sector M&A efforts, in a late June interview that came before the court's ruling.

Some companies thought to be most impacted by Obamacare and the Supreme Court's decision have already scaled into new business lines. Last October, Cigna (CI) bought HealthSpring (HS), a health care provider with a big pharmacy unit, in a near doubling of its PBM unit.

In June 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. The Supreme Court, however, limited the extension of Medicaid, deeming it unconstitutional for the federal government to withhold money from states that don't comply with the Act.

The Court's maintenance of the Affordable Care Act signals that Medicaid will expanded to some extent -- with the biggest impact to Medicaid HMOs like Amerigroup, Molina (MOH - Get Report) and Centene (CNC).

Some estimate that between 16 million to 20 million new Americans would be eligible to enroll in Medicaid through the Affordable Care Act.

Regardless of the Supreme Court's ruling, companies will be pressured to figure out a way to grow the bottom-line in a health care market that's likely to become far more cost-competitive. "We do not see that the cost trend today is sustainable, therefore to be a winner in the future you need to be bigger and have economies of scale," added Cabrera in June.

Recent deals like dialysis specialist DaVita's (DVA) $4.42 billion acquisition of privately held physician practice HealthCare Partners and health-insurer Humana's (HUM) acquisition of hospital chain Concentra in 2010 highlight how health care sector players are scaling their operations, noted Cabrera.

Still there are reasons to believe Monday's deal -- the largest in the healthcare space since the Affordable Care Act was passed into law in 2010 -- may be the peak of M&A in the sector.

"While certainly enhancing we don't see this as a game changer in terms of government focused capabilities for Aetna going forward," wrote JPMorgan analyst Justin Lake in a note to clients. "We do not see Coventry Health Care as bringing to the table market leading positions in either individual Med Adv (such as HealthSpring brought to Cigna) or Medicaid (such as Amerigroup brought to WellPoint)," he added.

Fischbeck of Bank of America, meanwhile, highlights that consolidation may be challenged in the healthcare space after Aetna's acquisition because both companies were the most likely consolidators and larger players like UnitedHealth Group could have faces antitrust scrutiny. "[We] see no reason for UnitedHealth Group to pay twice its P/E multiple for business it can win organically, before considering potential antitrust complications," wrote Fischbeck, in a note to clients.

"[Cigna] cannot do a transaction accretively given relatively high debt levels and prefers leveraging HealthSpring capabilities or local JVs. Meanwhile, [Humana] believes its partnership strategy (where it has had recent success with CareSource) is the most cost effective way to enter markets," added the analyst.

For more on investing in healthcare see why Express Scripts could be sandbagging synergies in its mega-deal for Medco Health Solutions and why sector M&A may trump weak earnings.

-- Written by Antoine Gara in New York
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