UnitedHealth's Merger Malaise

A key exec is poised to leave as the HMO tries to fold in another acquisition.
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OKLAHOMA CITY -- UnitedHealth (UNH) - Get Report can't seem to shake its merger-integration headaches.

Take a look at one small client, Sun Community Newspapers. For months after UnitedHealth completed its purchase of health care insurer PacifiCare back in December 2005, Sun Community faced an avalanche of errors on everything from enrollment plans to insurance cards to cancellation notices.

"It was constant, constant, constant," says Kelly Mayfield, associate publisher of the San Fernando Valley newspaper outfit, which saw its PacifiCare coverage shifted over to a UnitedHealth plan. "And we're a fairly small company. I can't even imagine if we had 200 employees."

UnitedHealth, the Minneapolis-based health insurance giant, concedes it has weathered integration setbacks. But after devoting "substantial time and resources," the company feels that it has made real progress.Mayfield agrees, saying the company has finally straightened out its issues and boasts a "fine program" once again.

But insurance agent Barry Cohn has his doubts. He has taken to warning his clients about PacifiCare's problems -- and even now forces policy buyers to sign waivers saying they have been warned.

"I still don't see things getting better," says Cohn, president of RGEB Employee Benefits in southern California. "It's pretty much a disaster."

The problems could mean trouble for UnitedHealth investors. The company is in the midst of trying to make another acquisition, a $2.6 billion buy of Nevada's

Sierra Health

(SIE)

. Meanwhile, UnitedHealth will soon lose President Lois Quam, a highly regarded executive known for her integration -- and overall leadership -- abilities.

Quam's departure "represents the loss of the most obvious choice of a successor to Steven Hemsley, the current CEO, should that be necessary," says CRT Capital Group analyst Sheryl Skolnick. "The timing bothers me more than the fact that she's moving on. ... I get the need to change after 18 years, but I don't get 'Why now?'"

Skolnick has a fair-value rating on UnitedHealth's stock. The shares, which peaked near $65 before scandal engulfed the company last year, inched up 22 cents to $49.34 on Tuesday.

Empire Building

Last month, Quam rattled the market with plans to end her celebrated 18-year tenure at UnitedHealth for a new investing career at

Piper Jaffrey

(PJC) - Get Report

. Over time, Quam has built UnitedHealth's Medicare business into a virtual empire -- which expanded greatly with the $8.1 billion buyout of PacifiCare -- and has convinced many that she could run the entire company.

But then Quam decided to quit, less than nine months after receiving a big promotion. She is leaving with the integration of PacifiCare -- one of her key jobs -- still unfinished and yet another big acquisition looming ahead.

Quam isn't the only key exec leaving UnitedHealth.The company announced the resignations of Quam and Richard Anderson, who led the company's core commercial division, on the same day last month.Anderson, promoted along with Quam back in December, recently returned to the airline industry as the new CEO of

Delta

(DAL) - Get Report

.

Anderson 's departure, at least, seemed almost expected.

"Since

his promotion, the company has fallen short of its enrollment growth expectations and is poised for a year-over-year reduction in commercial enrollment for the first time since 2000," Credit Suisse analyst Gregory Nersessian said last month.

Meanwhile, "UnitedHealth experienced negative reserve development in its commercial book for the first time in almost 10 years in

the first half of 2007.

"Given these factors, we are not surprised by Anderson's decision to pursue this other opportunity."

Still, Anderson's departure could bring further disruptions to a commercial division already challenged by a huge expansion program. Notably, the company is still trying to integrate PacifiCare even as it seeks to acquire nearby Sierra.

For its part, UnitedHealth insists that it has a strong management bench that includes "a new generation of experienced talent" -- personally groomed by the likes of Quam -- that is ready to take the company to a new level of success. But Skolnick sees trouble ahead.

High Sierra

After gaining a foothold in Las Vegas through its acquisition of PacifiCare, UnitedHealth will soon dominate the fast-growing market if its buyout of Sierra goes through as planned. UnitedHealth recently secured clearance for the deal from state insurance regulators despite allegations of past misconduct in dozens of other markets.

Just last week, UnitedHealth inked a $20 million settlement to end disputes involving 36 different states across the country. The company welcomed the deal, saying that it paves the way for simpler regulatory oversight going forward. Of course, some feel the deal also carried a relatively cheap price tag.

Even so, some outsiders expressed alarm.

"It's not the dollar amount," Skolnick stresses. "It's the embarrassment that this company -- which supposedly had the most sophisticated information and claims payment systems in the industry -- could be taken to task for a basic business activity like a persistent and apparently widespread inability to accurately calculate deductibles and pay claims promptly."

Critics have been pointing to UnitedHealth's spotty track record in discussions with federal antitrust officials who are reviewing the company's latest deal. Nevada health care providers, who treat huge crowds of Sierra customers, seem especially concerned.

The Nevada State Medical Association claims that UnitedHealth's buyout of Sierra would leave the company controlling nearly all of the Medicare business in Las Vegas and most non-Medicare business in the market as well. The group hopes to block the deal before that happens.

"Nowhere else in the country would an acquisition of a local product create such a level of consolidation," says Lawrence Matheis, executive director of the association. "So I don't think this is over by a long shot. The national implications of this

buyout make it anything but a certainty."

Wall Street clearly feels otherwise. Despite loud protests from Nevada health care providers -- and ongoing scrutiny by federal officials -- some analysts have already started adding Sierra's projected contributions into their UnitedHealth forecasts.

UnitedHealth itself believes that Sierra will boost next year's profits by about 4 cents a share before cost-cutting synergies. Ultimately, for a company expected to earn almost 100 times that amount -- even without the acquisition -- the impact looks rather small.

But for local health care providers, who count Sierra as their largest commercial payer, the impact looks anything but.

Kathleen Silver, interim CEO of University Medical Center in Las Vegas, says her hospital found it "very difficult" to resolve PacifiCare claims issues after UnitedHealth took over. Now, she worries that her hospital will face similar problems if Sierra winds up getting "Unitedized" as well.

"Sierra is already the 800-pound gorilla here," Silver says. "Now, it will be the 805-pound gorilla."

UnitedHealth says that it likes Sierra's current strategy -- which has proven highly successful -- and has no plans to transform the operation into "UnitedHealth-Nevada." But Matheis says UnitedHealth made similar vows about PacifiCare, only to break them 18 months down the road.

"We have no reason," he says, "to expect anything different" this time around.