Putting Politics Aside to Make Money
As value investors, we look for consistent growth in a wonderful
business that is currently selling at a discount. I believe that
the market is offering WellPoint Inc. (
), an established health insurance provider, at a discount to its
WellPoint and its subsidiaries supply health insurance to over
100 million individuals, and was formed when WellPoint Health
Networks and Anthem Inc. merged in 2007 (WellPoint, 2013).
WellPoint covers HMOs, PPOs, and POSs for both individuals and
companies. WellPoint also supplies insurance for the U.S.
government's Federal Employee Program and is also tied to the
government through Medicaid. Finally, WellPoint is a part of Blue
Cross and Blue Shield (BCBS) in 14 states and is licensed in all
To understand how to accurately value this company, we must first
comprehend the way in which the Supreme Court's ruling on the
Affordable Care Act (ACA) will impact the health insurance field
and the growth that will be accelerated or slowed due to the new
law. My thesis is the market has an irrational fear due to the
ACA, and as a result, has mispriced WellPoint. Contrary to the
market's fear, I believe that aspects of the ACA may actually
benefit WellPoint due to recent changes and acquisitions.
Furthermore, I believe that even though the market has begun to
recognize the opportunities that the ACA presents for WellPoint,
I believe the stock is still severely undervalued. The following
is my analysis of the market's fear of the health insurance field
and the irrational prices created due to the ACA, with an
emphasis on WellPoint.
The ACA aims to provide everyone with basic health insurance.
This includes those with disabilities and pre-existing
conditions, as well as the poor. The ACA forces employers to
provide coverage for their full-time employees, and failure to do
so is subject to a penalty. Further, all self-employed
individuals must be covered by a plan or are also subject to a
penalty. The individual mandate of the ACA essentially obligates
everyone to purchase health insurance whether they want to or
With this comes the inevitable rise in healthcare premiums. If
insurance companies are forced to accept patients with
pre-existing conditions, they will predictably raise premiums for
all plan participants to offset the losses that result from
accepting costly new customers. The market's fear is that this
will hurt the insurance company. However, I have an opposing
My first argument is the insurance companies can continue to
raise prices as necessary. Historically, this is the reason
insurance companies that lack competition have been able to
survive. People understand the need for insurance and often
overpay to be insured. This trend will continue into the future
as costs for insurance companies rise due to the ACA.
Critics of WellPoint argue that Congress is attempting to limit
the rise in healthcare premiums. This is essentially true.
However, this objective will be difficult to enforce because the
government has now put itself in the business of keeping
insurance companies afloat. If all health insurance providers are
forced to raise premiums due to increased costs, the government
will not be able to refuse. As a result, the government's talking
point of keeping premiums low will be difficult to execute.
Along with this, the government is putting pressure on health
service providers to lower their cost to customers. However, if
everyone is already insured, the government is effectively
attempting to lower costs for insurance companies, not the
customer. If costs are driven down, profits should rise for
One of the main reasons I believe insurance companies will be
able to increase revenues as necessary is due to a subsidy
provided to lower income individuals who were previously
uninsured. Subsidies will be available to those who make less
than 400% over the national poverty line, or roughly $92,000
(Wall, 2013). For practical purposes, most people would receive
some form of subsidy following these parameters. For example, a
person making 138% of the poverty line would pay only $520 per
year under a plan that costs $5,000. A full table displaying the
subsidy corresponding to each income level is shown below in
Table A (Young, 2013). This allows insurance companies to charge
more, the government to subsidize the premium, and the individual
to be less impacted by the elevated cost of health care.
Table A - Subsidies in Relation to Percentage of Poverty
Another intended result of the ACA is it encourages competition
between insurance companies by offering a website with
side-by-side insurance offers. Studies have shown that
individuals consistently select price as the determining factor
in deciding which plan to purchase (Wall, 2013). The result of
this will likely be lower profit margins for all insurance
companies due to increased price competition.
Although insurance companies already operate on single-digit
profit margins, the number of customers will have to grow due to
mandatory insurance. Nearly 84 million people who were currently
uninsured or underinsured (Gregg, 2013) will be forced to
purchase insurance. This should compensate for the lower margins
that will result from the implementation of the ACA. The key is
who will be able to withstand these thinner margins.
A major consideration that will benefit large health insurance
companies is government-operated health insurance may eventually
result in a situation similar to our "Too Big to Fail" policy in
the financial industry. Many small banks today are being shut
down due to the Dodd-Frank legislation that essentially
eliminates smaller banks due to burdensome regulation and
competition from larger banks. The same could soon ensue in
health insurance. When small health insurance companies see their
already small profit margins decline and are forced to compete
with large health insurance companies on price, business will dry
up and they will go broke. Customers who were previously insured
by smaller insurers will be forced into plans by larger insurers
such as WellPoint.
This is ironic because the objective of the ACA was to keep
health insurance affordable and encourage competition between
health service providers and insurers. However, the same
competition that drives rates lower also eliminates smaller
companies and will likely narrow the pool of insurers down to a
much smaller group. I suspect that this group will eventually
consist of WellPoint (
), United Health (
), Humana (
) and possibly a few others. By reducing the number of insurers,
the ACA's end result decreases competition. I believe that the
companies mentioned above will survive because of their large
customer base, ability to withstand smaller margins, and
pre-existing presence within government.
I believe that of these, WellPoint will emerge the strongest for
a variety of reasons. WellPoint recently acquired Amerigroup
(AGP), which focuses on Medicaid and elderly people with
disabilities (Hegarty, 2012). The acquisition of Amerigroup has
already added over 5 million new customers to WellPoint (Zhao,
2013). The ACA broadens the scope of Medicaid coverage, increases
the number of people on Medicaid, and allows companies such as
Amerigroup to pay lower rates of reimbursement (Weir, 2012).
Following the Supreme Court's ruling on the ACA, Amerigroup's
stock jumped 50%, a clear indication of the impact of the new law
on the company.
The acquisition of Amerigroup was a brilliant idea by management.
I believe it acted both as a hedge against the ACA as well as a
new way to generate profits and grow the company. The acquisition
occurred before President Obama was re-elected. I believe the
thought process behind the acquisition was that if Obama were
re-elected, the ACA would stay in place. As previously discussed,
this would squeeze WellPoint's margins. However, another effect
of the ACA is it expands the scope of Medicaid. WellPoint's
smaller margins would be offset by the acquisition of a company
that benefits from the ACA.
Pre-election critics of WellPoint maintained that the purchase of
Amerigroup was an extremely risky bet by WellPoint (Avik, 2012).
They asserted that if Romney won the election, Medicare and
Medicaid reform would take place and would likely be detrimental
to Amerigroup. This may have been a rational fear. However,
Amerigroup has proven to be a wise investment for WellPoint, as
the re-election of President Obama assures that the ACA and
expansion of Medicaid are here to stay.
WellPoint also operates under Blue Cross Blue Shield (BCBS) in 14
states. In those states, WellPoint controls over one-third of all
private insurance plans (Whelan & Dobbs, 2013). BCBS has
historically been able to offer lower rates than competitors
which will be to WellPoint's advantage in the competitive
post-Obamacare market. BCBS also gives WellPoint bargaining power
in these 14 states--something their smaller competitors do not
have. The national average discount rate from providers to
insurance companies is roughly 20%. However, BCBS often gets
discounts of upward to 60% (Whelan & Dobbs, 2013). In fact,
WellPoint has been voted least popular by hospital executives due
to tough negotiation tactics (Zhao, 2013). WellPoint cites BCBS
as the reason for this negotiating ability, and I believe the
expansion of the "brand" and "pricing" moats of BCBS into other
states is essential for the long-term growth and profitability of
An argument for the bears that are selling and driving the price
to current levels is insurance companies will not be able to
withstand smaller margins. Although this may be a rational fear
for smaller insurance companies that may go out of business due
to the ACA, this is not the case for insurance giant WellPoint.
As previously mentioned, WellPoint has the durable competitive
advantages of price, quality, ACA coverage, Medicaid coverage, as
well as other ties to the government. Large insurance companies
will be necessary for the ACA to succeed, and although lower
prices and profit margins can be expected, large insurance
companies such as WellPoint will not feel the impacts to the
degree that smaller insurance companies will.
In fact, it is quite clear that many large insurance companies
are in favor of parts or all of the ACA. We can see this by
looking at large insurance companies' political action. One of
WellPoint's peers, insurance giant UnitedHealth, lobbied heavily
for aspects of the ACA (NBC, 2012). The lobbying came when the
Supreme Court was interpreting the constitutionality of the ACA
legislation. UnitedHealth and Humana began lobbying for
provisions to keep aspects of the ACA in place even if the larger
legislation was declared unconstitutional. Because WellPoint,
UnitedHealth, and Humana operate very similarly, it is reasonable
to assume that WellPoint was also in favor of many aspects of the
ACA. As my theory holds, this should have been expected, as the
ACA will likely eliminate smaller insurance companies, thus
bringing more business to insurance giants such as WellPoint.
Now that the basic premises of the ACA in relation to the health
insurance industry have been established, I will explain why I
believe that WellPoint's stock will outperform its peers. I will
first analyze WellPoint's management and then move to growth and
profitability in relation to other companies in the health
One of the main arguments of the bears is the lack of stable
management. The former CEO, Angela Braly, was forced to resign in
August 2012 (Matthews & Camp, 2013). WellPoint appointed a
temporary CEO before committing to their permanent CEO, Joseph
Although relatively new, I believe the appointment of a permanent
CEO gives us more clarity into the future. If we had bought our
initial positions at $55 per share, the CEO and the company's
future would have been unknown. However, with Swedish, the
company's future can be projected with greater transparency.
Additionally, the bears are also wrong because the selection of
Swedish prepares the company for facing the new legislation.
Swedish has previously been in the hospital business and knows
the fine points of the interaction between health care providers
and health insurance companies. Swedish said upon selection, "My
medical background will help us forge closer ties between
WellPoint and providers in areas such as quality of care and
efficiency" (Fox Business, 2013). I believe that this selection
was appropriate for WellPoint considering the challenges and
opportunities that the ACA presents.
It is possible the change of management has already begun
impacting the company in a positive way. Although the success
attributed to Swedish in the most recent quarter should be
limited, WellPoint reported earnings per share of $2.94 versus
expectations of $2.38 and also raised its forecast for the
remainder of the year. Shareholders were both excited about the
earnings and outlook, as the stock rose 6% following the
Mark Giambrone, WellPoint's largest shareholder said, "The old
management team liked to overpromise and under-deliver, and
that's a disaster for the stock market. It is clear to me that
his (Swedish) focus is different" (Nussbaum, 2013). Giambrone
continued by saying, "What I like about him is his consistent
message about execution, operating efficiency and expense
control. Those are the things WellPoint had been missing,
frankly. I think the assets are there. Really, the question is
about execution." It seems that market participants agreed with
Giambrone, as the stock has made substantial gains since the
announcement of Swedish as CEO and the most recent quarter's
Even as shareholders viewed WellPoint's previous management
negatively, WellPoint has produced extraordinary return on
investment and return on capital while maintaining zero debt.
This is illustrated in Table B below. As shown, WellPoint has
been extremely diligent with equity and has produced consistent
returns ranging from 11-13% over the past 10 years. These
outstanding returns have put Wellpoint in the upper 6% of health
insurance companies (Gurufocus, 2013). The reason the previous
CEO was forced to resign was lack of proper money management and
business strategy. With the appointment of new and better
management, I expect these numbers to surpass previous growth
Table B - Investment Performance
As previously mentioned, the health insurance sector operates on
relatively small margins. Relative to the industry average of 4%,
WellPoint operates at 6.5%. This positions WellPoint in the upper
quartile of the health insurance sector in relation to profit
margin (Gurufocus, 2013). As my previous theory holds, I expect
WellPoint's margins to outperform its smaller competitors after
the entirety of the ACA is implemented.
WellPoint is also attracting new customers while raising prices.
Its revenue growth of nearly 9% ranks WellPoint in the top 10% of
all health insurance companies. As previously hypothesized, I
presume revenue will continue to grow at an even faster rate in
the future as the ACA drives prices higher. Because I anticipate
fewer health insurance companies will exist 10 years from today,
I believe its rank relative to others will also continue to rise.
The company is buying back a substantial number of shares and has
begun to return capital to shareholders in recent years.
WellPoint began distributing a dividend in 2011, and weeks ago
increased its dividend by 30% (See Table C and D below). Only 10%
of companies are buying back shares at a faster rate and only 12%
of health insurance companies pay a higher dividend than
WellPoint's $1.50 (2%) dividend. With no debt and accelerating
operating cash flow per share (Table E), I consider stock
buybacks and dividends suitable for the company.
Another relevant consideration is the price at which WellPoint is
buying back its shares. Not only is it a positive sign the
company is repurchasing stock, but also as we will soon see, the
company is buying back shares at a discount to BVPS, a five-year
payback time, and nearly half of the sticker price. For these
reasons, I strongly agree with the company's ongoing share
Table C - Recent Share Buybacks
Table D - Recent Dividends (Excluding 2013)
Table E - Operating Cash Flow Per Share
Even more compelling than these figures is that the shares are
inexpensive at the current market price. The stock is currently
trading for 8.5 times earnings, putting WellPoint in the lowest
12% of P/E ratios of all health insurance stocks. The health
insurance industry itself has a low P/E ratio of only 10.5
compared to the Russell 2000 P/E of roughly 16. I believe this
low P/E is mainly due to the uncertainty surrounding the ACA, as
The fundamentals of WellPoint are sound; Table F below shows EPS,
OCPS, Sales, and BVPS+Dividend growing consistently at
approximately 10% per year. This consistent profitability growth
in combination with management's ability to efficiently allocate
capital makes WellPoint an attractive investment.
Table F - 10-Year Growth Rates
The question now becomes whether WellPoint is "on sale." If we
assume a conservative growth rate of 11%, the sticker price is
determined to be $126 with a margin of safety of $63. The stock
is currently trading at roughly $73 per share. Although we cannot
buy the stock on the grounds of MOS, there are many other reasons
to buy at the current market price.
One reason to buy WellPoint now is that it has a payback time of
five years and an eight-year payback of $108 (See Table G below).
This again assumes a growth rate of 11%.
Table G - Valuation
A second reason to buy now is WellPoint has a BVPS of roughly $78
(see Table H). This shows that the stock is now trading at a
discount to its tangible book value. Its closest peer,
UnitedHealth (UNH: NYSE), is trading at $60, has a P/E ratio of
11.5, an MOS of $40, a payback of $63 in eight years, and a BVPS
of $27, making UnitedHealth a much less attractive investment on
the grounds of valuation.
Table H - Book Value Per Share
Although UnitedHealth has better ROI, ROE, and equal growth, I
believe that WellPoint is the better investment due to its
greater discrepancy between price and value. Also, WellPoint is
trading below BVPS while UnitedHealth is trading at roughly
double BVPS. Additionally, I believe WellPoint will outperform
UnitedHealth due to its competitive advantages such as better
management, ties to government programs, and Blue Cross Blue
Shield. For these reasons, I believe WellPoint to be the best
investment in the health insurance industry.
It appears that I am not alone in this belief. Value investor
recently added shares to his already existing position in
WellPoint (Gurufocus, 2013). Although he initiated his position
near $55 per share, he recently added 47% more at a higher price.
This shows that other value investors may possibly see the same
price and value discrepancy as I do in.
Ideally, we would have made our initial investment at around $55
per share when Loeb was investing; however, I believe the upward
movement in the stock is just the start of a much larger bull
run. Following earnings, WellPoint broke out of the key technical
level of $70 (See Table I below). If it can maintain above this
ceiling, $70 is likely to become a new floor.
Table I - Key Technical Levels
Another technical advantage is presented by using Fibonacci
Retracements. WellPoint's stock movement is a perfect example of
these expected retracements. As shown in Table J below, I took
the more recent floor and ceiling and extended Fibonacci
Retracements. It worked perfectly that the next Fibonacci level
is at its previous ceiling of roughly $82. This is an approximate
14% increase from the current market price of $72. If the newly
established floor holds, I expect WellPoint to go to $82 in the
relatively near future. After reaching $82, I would expect it to
test its all-time high of $90 before moving higher.
Table J - Fibonacci Retracements
For these fundamental and technical reasons, I believe WellPoint
is a solid buy at the current market price. I would begin
stockpiling by purchasing one tranche at the current market price
and selling puts at the technical levels of 65, 60, 55, and 50.
This is illustrated in Table K below. If WellPoint dropped to
$50, we would have initiated all positions we wished to enter and
the stock would be trading at roughly 70% of BVPS. At these
levels, I would feel very confident in the investment.
Table K - Tranches
Options are trading slightly higher than their historical
average, with current implied volatility of 0.2467 and historical
volatility of 0.2124 (see Table L below). This shows current
volatility is roughly 16% above its historical average,
suggesting we will get paid slightly more than normal for selling
puts to enter into new positions. If we had entered these
positions when Loeb did following the ACA Supreme Court ruling,
we would have been rewarded with higher premiums at a lower
strike because of a volatility rush. Volatility spiked to 0.50,
or 238% of its historical volatility.
To get paid more for selling options, we may have to wait for
another volatility rush. If we were to sell the June 65 put today
(10% away from the market), we would get paid $0.50, a 1% return.
I wouldn't recommend entering this trade yet due to its low
return, but would wait to see if the current floor holds. If the
stock breaks beneath the floor, volatility will increase and the
premium for the 65 and 60 puts will pay a greater premium. We
would then be able to enter additional tranches at these levels.
Table L - Implied/Historical Volatility
I believe that WellPoint presents an excellent opportunity for
value investors from both a technical and fundamental standpoint.
My hypothesis is the ACA will help, not hurt, WellPoint by adding
customers and drive smaller competition out of the market.
Finally, I believe WellPoint offers a solid management team, has
a durable competitive advantage, and is selling at a discount to
its true value.
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