A “Supreme” Lift for Wellpoint

Submitted by Investing Daily as part of our contributors program.

By: Benjamin Shepherd

The US Supreme Court ruled in June that the Patient Protection and Affordable Care Act (PPACA) passes constitutional muster, up­holding the individual mandate and striking down only one provision of the law.

I largely expected this outcome. I won’t comment on the wis­dom of the law, but in the wake of the ruling the health care sector has been the top performer.

Health care providers and insurers anticipate about 35 million new cus­tomers and billions of dollars in ad­ditional spending, when the law’s re­quirement for every American to carry insurance or pay a penalty comes into effect by 2014.

Despite the top court’s ruling, PPACA isn’t completely out of the woods. Republicans have made the law’s repeal a major plank in their 2012 campaign platform. However, with Republicans and Democrats in a statistical dead heat in most of the key November races—including the one for the White House—it looks likely that it will take at least anoth­er four years for any repeal efforts to gain traction, by which point the law will be entrenched.

Now could be a good time for investors to look at a WellPoint (NYSE: WLP).

Covering approximately 34 mil­lion patients in 14 states, WellPoint is one of the largest managed care companies in the nation. It is also one of the largest in terms of the number of medical practitioners offering their services through Well­Point’s insurance networks.

The size of its network has al­lowed WellPoint to develop sub­stantial pricing power in its mar­kets. Moreover, being the exclusive licensee of the trusted Blue Cross Blue Shield name has made the company extremely attractive to its target market of small businesses.

Despite its clear advantages, Well­Point has been walloped in the mar­ket after it announced its intention to buy Amerigroup (NYSE: AGP) for $4.5 billion. Ordinarily, such an announcement wouldn’t be a major market-moving event, particularly since WellPoint expects the deal to add at least $1 to earnings per share within the next two years.

How­ever, the perceived problem is that Amerigroup primarily serves 2 mil­lion Medicaid patients in 11 states.

Although the Supreme Court up­held the majority of PPACA, it struck down the provision that would have allowed the federal government to withhold all federal Medicaid funding from states that did not participate in the expansion of the program called for under the law.

Republican governors al­ready have said that they will re­fuse to participate in the Medicaid expansion, spooking investors who worry that WellPoint is making an acquisition in anticipation of a mar­ket development that may not come to pass.

It is not my job to espouse any po­litical position. However, sheer prag­matism dictates that the Medicaid expansion is likely to occur because it will benefit hundreds of thousands of people in each state, primarily children, the poor and the elderly.

What’s more, the federal govern­ment is picking up the entire tab for the revamped Medicaid program through 2016, with states only re­sponsible for about 10 percent of the cost thereafter. Refusing to ac­cept this largesse could make for tricky campaigns in the next elec­tion cycle, even in the most conser­vative states. Advocates for the poor and many hospital associations al­ready are pushing back on guberna­torial efforts to opt out of the law’s Medicaid plan.

While a few states may ultimately decide not to participate, I expect most to acquiesce. Within Amerigroup’s coverage area, Texas and Flor­ida are the only states in danger of not joining the Medicaid expansion.

Consequently, WellPoint’s acqui­sition of Amerigroup should not only net it about 2 million new cus­tomers, but also allow it to claim a bigger slice of the estimated 18 mil­lion Americans who would be cov­ered under the broader Medicaid program.

Even if the law’s Medicaid ex­pansion were to hit some bumps in the road, the acquisition of Ameri­group is a savvy decision, as a grow­ing number of states privatize their Medic­aid plans to cut costs and improve cover­age. By acquiring Amerigroup, Well­Point will get the systems it needs to better compete for privatized Medicaid business.

In addition to these tailwinds, WellPoint is attractively valued, trading almost on par with its book value and at a small discount to its expected earnings growth. Well­Point also pays a small quarterly dividend with a current yield of 1.8 percent. Check out Medicaid Nation: Winning and Losing Healthcare Stocks under Obamacare for more stock picks that could benefit from the Patient Protection and Affordable Care Act.