For the first time in recent memory, a major Wall Street analyst has started warning investors to sell their stock in UnitedHealth Group ( UNH).

Goldman Sachs analyst Matthew Borsch kicked off the week by reiterating his underperform rating on UnitedHealth, even with the stock nearly 15% below its late-December high. Borsch listed multiple reasons for his contrarian view.

He cited falling profit at recently acquired PacifiCare, possible problems with earnings quality, near-term integration risks, marketplace "noise" about declining customer service and the company's poor ranking on corporate governance scores when explaining his bearish view on Sunday.

Borsch initiated his underperform rating on UnitedHealth two months ago, around the time that the company wrapped up its acquisition of PacifiCare and released fourth-quarter results that failed to excite investors. In contrast, other Wall Street analysts have continued to recommend that investors buy or hold the shares.

The stock, which peaked at a record $64.61 as 2005 drew to a close, tumbled 2.5% to $54.75 on Monday.

Red Flags

Borsch has voiced some troubling concerns about the company's PacifiCare division in particular. Based on state insurance filings, he says, PacifiCare saw earnings in its major market of California cut in half during the latest quarter. He cites a big spike in medical costs as the reason.

At the same time, Borsch raises questions about the company's earnings in general. Notably, he points out, the company's medical expenses have been climbing even while its reserves for medical claims have remained virtually unchanged.

"While this trend has been attributed to an acceleration in the claims cycle, the recent 10-K disclosures show that the percentage of medical claims incurred and paid during the current year actually declined in 2005," Borsch writes. Thus, "we highlight the risk that some portion of the $540 million in favorable prior-period reserve releases recognized during 2005 (worth 26 cents of earnings per share) may not have been fully replenished, suggesting a possible decline in the quality and underlying strength of earnings."

Borsch points to a deteriorating cash flow metric as well. Specifically, he notes, the company's ratio of cash flow to net income -- which tends to handily exceed 100% -- fell to 95% in the latest quarter.

Going forward, Borsch sees other challenges looming. He points out that UnitedHealth has pursued numerous acquisitions over the past couple of years and warns that integrations risks -- beyond those anticipated by Wall Street -- remain.

Indeed, his latest report suggests, UnitedHealth has already started to suffer some growth-related pains.

"For the first time that we're aware of, multiple competitors to UnitedHealth are pointing to marketplace 'noise' suggesting that service levels at UNH may have slipped or be slipping," Borsch writes. "While it remains unclear if the alleged service issues will prove to be a 'bump in the road' or something deeper, we surmise they may reflect the unavoidable strain from UNH integration of multiple large-scale acquisitions coupled with the task of servicing more than 4 million new AARP-UNH Medicare drug plan members."

In the meantime, Borsch notes, United Health has found itself saddled with a poor corporate governance rating from Institutional Shareholder Services. Specifically, he says, the company scored in the bottom quintile of large-cap managed-care players in the latest ISS study.

UnitedHealth fell short on some compensation matters in particular. The company has, by now, become well known for handsomely rewarding its executives.

UnitedHealth CEO William McGuire raked in $7.7 million worth of salary and bonuses last year. Perhaps more noteworthy, however, McGuire has since gone on to cash in 2.3 million stock options -- worth a whopping $125 million -- since that time.

Ongoing Challenges

Still, even Borsch foresees no "collapse" in the company's earnings.

Rather, he predicts an inevitable slowdown in profit growth that will lead to a contraction in the company's price-to-earnings ratio. And he warns investors against counting on Medicare -- which is undergoing its biggest expansion in history -- to bail out the company.

"While Medicare is often cited as the investment rationale for UNH, we highlight that traditional commercial health insurance risk remains the critical factor, comprising close to 50% of company-wide earnings for 2006," he says. "By contrast, Medicare ... will represent just 12% and 14% of company-wide earnings in 2006 and 2007 -- even under very robust Medicare earnings growth assumptions."

Borsch doubts that big acquisitions will keep helping the company out, either. He believes the government has already started pushing back against further consolidation in the industry. Meanwhile, he cites regulatory problems involving UnitedHealth in particular.

Just last week, he points out, UnitedHealth found itself slapped with the biggest fine ever levied against an insurance company by the state of Arizona.

Following a recent "market conduct examination," the Arizona Department of Insurance made UnitedHealth pay $364,750 for alleged violations of state laws. It also ordered the company to correct its practices going forward.

"These are significant findings in areas that directly affect members and providers," the department's director, Christina Urias, said of the review. "I will continue to insist that insurers and HMOs follow the law when it comes to processing member appeals or provider claims and grievances, and the department will monitor these practices in the future."

Borsch, for one, senses reason for concern.

"While the amount of the fine is immaterial to UNH," he concedes, "the pattern of apparently repeated violations is troubling."

On a similar note, Borsch points out that UnitedHealth could face an even bigger penalty ahead. He notes that UnitedHealth has yet to settle a major class-action lawsuit that has been pending against the company for years. In contrast, he says, two major competitors -- Aetna ( AET) and Cigna ( CI) -- have already paid $160 million each to put that same litigation behind them.

UnitedHealth instead hopes to see that case, filed by a group of physicians, dismissed at a court hearing on Tuesday. But if the company fails, Borsch says, it faces a courtroom trial this year.

In the meantime, Borsch continues to steer his investors elsewhere.

"If investing in large-cap managed care, buy AET and sell UNH," he suggests. Goldman Sachs counts both UnitedHealth and Aetna as investment banking clients. "While both AET and UNH are exposed to sector risk ... we believe AET's focus on organic growth coupled with its strong resurgence among employers will help support upside to the stock or -- in a downside scenario for the sector -- at least provide sector-relative out-performance."