Stock Mart: American Medical Security

Small-group insurer American Medical Security's (AMZ Quote) stock price hasn't been too healthy lately, but all it may need to stage a recovery is a dose of confidence from Wall Street.

The Green Bay, Wis., health insurer's stock has been sick since the company announced on May 24 that it would take a charge of $6 million, or 36 cents a share, in the second quarter to shore up medical claims reserves. The charge and the "adverse medical loss ratio trend" the company identified also promised to push this year's earnings below analysts' expectations. The stock plunged 35%.

But a money manager and a sell-side analyst say at these prices American Medical Security represents a value -- and possibly a takeover candidate.

"This isn't a concept stock. They are making money," says the money manager who owns the stock but asked to remain anonymous. "They are extremely cheap. The P/E is very understated. ... These guys are going to get bought out at these prices or the price is going to improve."

AMS is expected to earn 71 cents a share this year and $1.05 for next year, according to First Call. So at its Friday close of 10 1/8, up 3/16, the company's price-to-earnings ratio for this year is 14.3 and for next year is just 9.6. The company also trades just above its March 31 book value of $9.13 per share and has a price-to-sales ratio of 0.16. Value investors shoot for price-to-sales ratios below one.

One sell-side analyst, Walter Morris at Robert W. Baird in Milwaukee, agrees that the stock is a potential takeover candidate. He points to other sector takeovers, including Fortis Insurance Group's takeover of John Alden Life Insurance in 1998. AMS' primary business is the small-group market for less than 25 employees.

"I'm sure there would be a number of people interested in it," Morris says. (AMS was a unit of United Wisconsin Services until September 1998 when it spun off United Wisconsin. Robert W. Baird worked on that transaction and has an investment banking relationship with United Wisconsin. AMS spokesman Cliff Bowers says United Wisconsin still has a stake in AMS.)

It's AMS' own pursuit of growth through acquisitions that put its stock into the current situation. In October 1998, the company agreed to buy the employers health insurance business of CNA Financial (CNA Quote) after having bought Pan-American Life's health business earlier in the year. It took on CNA's claims in February and that's when the company says the problems began.

Because of a backlog in claims that it got from the CNA business, AMS' own claims processing got backed up as well, and the company failed to note a medical loss ratio trend. In other words, the money manager says, the firm was short-handed and was making its medical obligation estimates on claims it had already received and not processed.

So investors fled the stock. But the charge, the money manager says, had far too big an impact. The decline pushed AMS' market cap down -- it's now at $165 million -- and off most investors' radar screens, the money manager says. "Until these guys do something that makes people care, no one is going to care."

Robert Hoehn, an ING Baring Furman Selz analyst, remains concerned about the company's ability to recontract parts of its businesses at higher prices. (ING hasn't done any underwriting for the company.) But Morris at Robert W. Baird says the company has been raising premium rates dramatically.

Morris also is counting on the company's less than two-year-old management team, led by Sam Miller, chairman, president and chief executive, to make investors interested in the stock again. The business that they underestimated was an old book that predated current management, and the health insurance industry is coming around, he says.

"Intermediate and long-term, we are a strong believer in Sam Miller and his efforts to create a lot of value for shareholders here," Morris says. "We think the health-care and insurance business is in the early stages of a recovery."

Morris' price target for the stock is 13, while the money manager says he's looking for 15.

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