Editor's note: This column was submitted by Stockpickr member Winston Kotzan.
As we rapidly approach the 2008 presidential elections, one political issue has reignited an old debate -- health care. A topic sure to be a critical factor in this next election will be how the candidates plan to insure the 46.6 million American citizens who have no medical insurance.
To examine this topic from an investing perspective, I performed an in-depth study of the largest health insurer by membership, Indianapolis-based
First, Some Background
WellPoint was formed as a result of the 2004 merger between WellPoint Health Networks Inc. and Anthem Inc. It is currently the largest provider of health care plans in the U.S. by membership, with more than 34 million members as of Dec. 31, 2006. Its 2006 annual revenue of $57 billion was only surpassed by
$71 billion in revenue.
As the Blue Cross Blue Shield Association licensee in 14 states, WellPoint has one of most the recognized marketing brand names and provider networks in the health insurance industry. Earlier this year, the company appointed a new CEO, Angela Braly. The company has also announced plans to restructure its internal operations into three separate business units: commercial, consumer and a comprehensive solutions unit for health care providers.
Valuation Based on Organic Growth
To determine the impact of the presidential candidates' proposals for the health care industry, and in particular WellPoint stock, I built a discounted cash flow (DCF) model for WellPoint. As a control comparison, I ran a default set of assumptions through the model.
This initial scenario assumed that WellPoint grows organically through 2011, using revenue growth projections for each of WellPoint's businesses sourced from the sell-side research analysts at CIBC World Markets. I based profit margins on recent historical financial data.
After running the model several times, it suggests a current valuation of $88.50. Clearly, even at today's stock price, the model indicates that WellPoint stock may be slightly undervalued. The stock closed Tuesday at $84.92.
Valuation With Presidential Proposals
After the initial runs of my DCF model, I factored in the impact of Hillary Clinton's proposal if it were to be enacted into law. Hillary's proposal is by far the most ambitious of the presidential candidates' plans, making health insurance, much like auto insurance, mandatory for all citizens.
Surprisingly, adding Hillary Clinton's proposal to the valuation model had little impact on WellPoint's stock price. Despite assuming WellPoint achieves a 10% market share of the uninsured,
the model suggests the proposal would add about $2 per share to the stock
I attribute this to rather conservative estimates. Clinton's plan assumes that America's roughly 44.6 million uninsured can be covered for about $110 billion, or $195 per member per month (PMPM). Compared to commercial plans of about $260 PMPM, Clinton's plan seems to offer limited coverage. The model also assumed an 85% medical loss ratio (MLR) on the added revenue.
Looking at the Republican plans, I doubt that they would cause great change for the health care industry. Candidates including Rudy Giuliani advocate large income tax deductions to make so-called health savings accounts more attractive. Such plans provide little additional revenue to companies like WellPoint and likely would have virtually no impact on the uninsured.
Government Spotlight Is Good, but ...
While increasing attention from political candidates may be good for the health care industry, it does carry some caveats. As politicians hope to insure more of the population and keep premiums low, there is a temptation to impose legislation limiting the profit margins of health insurers.
One such example is California's proposed insurance plan, which sets an 85% MLR. If such a strain on profit margins were nationally imposed, it would be a back-breaker for many companies like WellPoint. Hillary Clinton supports MLR quotas, but so far has not specified details. I suggest eyeing the political proposals with caution as we approach the 2008 election and beyond.
Mortgage Market Contamination?
It should be noted that, according to its 2006 10K, WellPoint has invested $5.5 billion in mortgage-backed securities, $300 million of which are subprime loans. These are the nasty securities that have wreaked havoc on investors and Wall Street this past year. I feel that an impairment of WellPoint's MBS holdings is likely.
Although WellPoint's investment income comprises a small portion of revenue, a writedown of the MBS assets could disrupt asset liquidity and negatively impact shareholder-friendly initiatives such as a stock-buyback program.
Given the recent rally of WellPoint's stock price, I feel neutral about this company as a portfolio holding. While the long-term outlook seems positive, it is tainted by the possibility of increasing government regulation and mortgage investments.
For more a more in-depth look at my analysis, you can download an excel file of my WellPoint DCF model at
At time of publication, Kotzan had no positions in stocks mentioned, although positions can change at any time.
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