Carrier Catches Merger Fever

A buyout offer this month caught Health Net Inc. in the wave of consolidation sweeping the industry as insurers seek to increase market share and cut costs amid the opportunities presented by the Affordable Care Act. But for employees of the Woodland Hills company, the $6.8 billion acquisition by Centene Corp. announced July 2 arrived just in time to avoid a pink slip. Months earlier, Health Net had announced an agreement to lay off 1,174 employees at its headquarters, saying most would be rehired by contractor Cognizant Technology Solutions Corp. of Teaneck, N.J., to perform the same work. Health Net expected to save between $150 million and $200 million annually by outsourcing its claims management, customer communication, and grievance services to Cognizant. The layoffs and “rebadging” of employees had been scheduled for June 30. In addition, 43 workers were scheduled for termination without Cognizant jobs – but the deadline was pushed back, and a few days later the deal with St. Louis-based Centene put the massive job shuffle on hold. One employee, who requested anonymity, said the acquisition brought both hope and more confusion. “At 11:59:59 within losing my job via outsourcing, I am now still employed. … All here were shocked at the announcement on (July 2), and most are happy ,” the employee stated in an email to the Business Journal, adding there was an expectation the Health Net brand would remain given its high profile in the California, Arizona and Oregon markets. Brad Kieffer, spokesman for Health Net, said it’s too early to know what will happen with the local workforce. Specifically, while the headquarters will certainly move, it’s not clear how many employees the combined company will need to retain to run its business in California. Still, the acquisition would mean the greater Valley would lose the headquarters of yet another publicly traded company. Last month, Kythera Biopharmaceuticals Inc. in Westlake Village was acquired for $2.1 billion by Allergan plc, and Ryland Group Inc. in Westlake Village announced a merger with Standard Pacific Corp., putting two other headquarters on the relocation bubble. Centene and Health Net said they expect to save about $150 million a year by combining the two companies. The savings would come in administrative and IT functions – the same places the Cognizant deal aimed to save money. Kieffer at Health Net stressed that the Cognizant deal is on pause pending regulatory approval of the acquisition. If the deal happens, the Cognizant deal would be terminated permanently. “If the Centene agreement doesn’t close, we expect we would resume the efforts with Cognizant at later date,” he said. “The boards have signed this definite agreement and now it’s subject to stockholder and regulatory approval.” Investor uncertainty In addition to employees, the acquisition also raises questions for investors and the greater Valley economy. Under the acquisition agreement, Health Net shareholders will receive 0.622 shares of Centene stock and $28.25 in cash for each share of Health Net stock. The payment represents a 21 percent premium over Health Net’s closing stock price on July 1. After the transaction, Centene shareholders would own 71 percent of the combined company and Health Net shareholders would own 29 percent. Thomas Carroll, an analyst at Stifel Nicholas & Co. in Baltimore, notes that the companies have very little overlap, so the combined company would gain from both enhanced insurance products and geographical expansion. In particular, it would become a powerhouse in managing government insurance programs, such as Medicare, Medicaid, the Department of Defense insurance system and veterans’ programs. The combined company would have 10 million policyholders and $37 billion in revenue, with more than 6 million of those policyholders of the managed Medicare variety. But size doesn’t negate the risks, Thomas noted. “Given the uncertainties around synergies and Health Net’s Cognizant relationship going forward, our estimates are under review,” he wrote in a note to investors on July 2. “Health Net is by far the largest deal in Centene’s history. Integration risks are real.” Likewise, A.M. Best, an insurance industry credit bureau in Oldwick, N.J., has started a “review with developing implications” for the BB credit rating of $400 million in Health Net unsecured notes due in 2017. In a statement, the company said its review “reflects A.M. Best’s concern regarding the execution and integration risk related to the transaction as well as the capitalization of the entities post-close.” Credit ratings are used by investors and consumers to judge the financial stability of an insurer, so any downgrade could translate to higher interest rates for Health Net on bond issues or loans. Economic implications The Centene-Health Net acquisition comes at a time when other large insurers are trying to consolidate, indicating the shared thinking that scale is a virtue in the new health care marketplace. Aetna has announced an offer to buy Humana for $37 billion, and Anthem Inc., the Indianapolis parent of Anthem of California in Thousand Oaks, has tried to buy Cigna for nearly $54 billion. Gerald Kaminski, director of the UCLA Center for Health Policy Research, said the June 25 Supreme Court decision that upheld subsidies under the Affordable Care Act has resolved uncertainty about the future of health reform in the minds of senior executives, clearing the way for deals to achieve greater scale. “This is about gaining market share on a national playing field, a bigger slice of the Medicare managed care market,” he said. “Centene is a company that plays in a lot of other markets, but not California. Centene could have gone into California and gained Medicaid market share, or they could buy Health Net.” Among employees, the lack of overlap between the company bodes well for job security. In the email, the employee who requested anonymity noted “the fact that Centene does not have the same lines of business as Health Net encourages thoughts that they will need to keep many of us.” A Health Net relocation would impact the West San Fernando Valley office market, which had a vacancy rate of 16.5 percent in the first quarter – one of the highest in the region – according to brokerage Colliers International. According to Health Net’s annual report, the company leases more than 115,000 square feet at its 21650 Oxnard St. headquarters in Woodland Hills, with the lease set to expire at the end of 2017. Rent payments total about $2.9 million annually, based on filings with the Securities and Exchange Commission. The company also leases another 334,000 square feet for its Western Regions operations at Hines Warner Center, 21271-21281 Burbank Blvd. in Woodland Hills, with a lease expiration in 2021. Kevin Fenenbock, a broker in Colliers’ Encino office, said that if Health Net moved a large part of its workforce, it would represent a setback for the West San Fernando Valley. “To lose a tenant like Health Net would be a significant hit,” he said. Fenenbock noted that so far this year, the entire Valley has decreased office vacancy a little more than 100,000 square feet. “It’s good, but it’s baby steps forward. This move would be a significant step back, especially for Warner Center which has struggled.”