This week, UnitedHealth ( UNH) hopes to shift investors' focus from its CEO's profits to the company's own.The giant health insurer -- long considered the industry bellwether -- looks poised to deliver another strong quarterly report on Wednesday morning. Wall Street expects the Minnetonka, Minn., company to make 68 cents a share, up from 61 cents a year earlier, according to Thomson Financial. Analysts expect revenue, lifted by a major acquisition, to surge 61% from a year ago to $17.9 billion. A strong showing could soothe investors who have grown nervous about the sector. But even solid results may fail to calm those who have been dwelling on the controversial stock option grants that reportedly handed CEO William McGuire some $1.6 billion in unrecognized stock option gains. "Unless it can resolve the options issues between now and July 19, second-quarter results probably won't have much of an impact on the company's stock price," CIBC analyst Carl McDonald wrote earlier this month. "We think the stock is likely to be range-bound until the options controversy is put to rest." Sheryl Skolnick, senior vice president of CRT Capital Group, agrees, though she adds that investors will still be watching enrollment and pricing trends. "What we learned from last quarter was that, if you miss your enrollment targets, your stock goes down 2% to 5%," Skolnick notes. "But if your pricing looks aggressive -- let alone irrational -- your stock goes down 25%. ... So I think there is a lot of twitchiness about the industry this quarter." UnitedHealth stock, which peaked above $64 late last year, rose 13 cents Monday to $47.68.
Grant's Tomb?UnitedHealth ranks among the most prominent companies caught up in a sweeping government probe of corporate stock option grants. The company came under scrutiny a few months ago after years of regularly rewarding McGuire with low-priced stock options that transformed him into a paper billionaire.
Government investigators have been trying to determine whether the company improperly backdated those options, pricing them below the market value of the stock, so that they would be worth more to McGuire and other executives. UnitedHealth has expressed confidence in its past practices while promising to investigate the matter on its own. In the meantime, the company has already altered its compensation policies significantly and
set plans for an earnings restatement. But it has yet to share the findings of an internal probe that has now dragged on for months. Many investors fear McGuire, a visionary who has built the company up from practically nothing, will be forced out in a top-rank reshuffle. Still, McDonald sees the potential for an upside surprise as the year wears on. He cites four primary reasons. First, he says that UnitedHealth has raised its prices by more than medical costs are projected to grow. Second, he says that the company could realize more synergy-related savings from its big PacifiCare acquisition than it had first predicted. Third, he says that the company could post higher margins on its booming new Medicare business than it had anticipated. And finally, he says that the company could very well repurchase even more stock than it has already promised to buy. As a result, McDonald believes that UnitedHealth could beat its full-year guidance -- which currently stands at $2.88 to $2.92 a share -- by as much as a dime. McDonald expects UnitedHealth to hit Wall Street targets for the second quarter in the meantime. His own earnings projection for the company matches the consensus estimate. He differs from his peers in another way, however. "Over the past few quarters, there has been growing scrutiny by the market around enrollment growth at United and the rest of the industry," McDonald notes. And "this is somewhat puzzling to us."
Notably, McDonald says, companies like United have been promising commercial enrollment growth from low-margin administrative accounts instead of from more traditional -- and lucrative -- risk-based business. Thus, he says, the companies can miss their commercial enrollment targets and still weather no real hit to earnings at all. UnitedHealth has seen its own earnings shaped by another crucial metric -- so-called prior-period developments -- instead. By releasing excess reserves, the company has regularly boosted its earnings. However, McDonald believes the company will recognize a smaller favorable development this time around. If so, Skolnick could grow worried. "Whatever it is," she says of the prior-period development, "I want it to be consistent. ... If the reserves are lower, there's not as much cushion there."
Game of RiskSkolnick, like many, will be paying close attention to UnitedHealth's medical cost ratio as well. For some time, Skolnick notes, UnitedHealth has predicted that its medical cost ratio would remain flat -- or even rise a bit -- and then has gone on to report a drop in that crucial figure instead. Still, Skolnick doubts that number can fall much lower going forward. For health insurers -- which have rallied in recent years on moderating medical cost trends -- any shift in this metric can significantly impact earnings. The medical cost ratio represents the share of each premium dollar spent on medical care. So an uptick would trigger some investor concerns. Of course, UnitedHealth investors have some big worries already. After all, some have speculated they could lose their CEO -- the visionary behind the company's phenomenal growth -- as a result of the options scandal. Just Monday, Bloomberg reported that government officials this week "plan to file criminal charges in the first enforcement case to emerge from the current options scandal." Bloomberg then went on to say that at least 12 similar cases will likely follow. To be sure, UnitedHealth seems to be taking the matter seriously. Notably, McDonald points out, the company has hired a former enforcement chief for the Securities and Exchange Commission -- who examined the conduct of both Enron and WorldCom -- to carry out its internal investigation.
McDonald, unlike some, believes that current UnitedHealth leaders will survive that probe. He, therefore, continues to maintain his overweight rating and his $62 price target on the stock. "At the end of the day, we think there is a higher probability the current management team at United remains with the company than of anyone being ousted," writes McDonald, whose firm hopes to secure investment banking business from UnitedHealth over the next three months. "But from a stock price perspective, we don't think it matters. In our view, United's stock is already discounting" McGuire's departure. "What the stock is not discounting," he adds, "is a clean sweep of United's executive management suite."