Want proof that healthcare stocks are poised to reap rewards from Obamacare?
Just take a look at this recent blockbuster healthcare merger.
Giant managed care firm WellPoint Inc. (WLP:NYSE) announced July 9 that it would buy Amerigroup Corp. (AGP:NYSE), the country's largest private Medicaid managed care company, for $4.9 billion (B) in cash.
The day acquisition was announced, Amerigroup stock jumped 38%.
You might also like. . .
Will Mayo v. Prometheus Fire Up Pharma?: Kevin DeGeeter
Of course, healthcare mergers and acquisitions (M&A) are nothing unusual. But a close look at this deal sheds light on the direction of the next major trend of consolidation within the industry.
In fact, when it narrowly upheld the Affordable Care Act (informally known as Obamacare), the Supreme Court unwittingly set the table for a new wave of M&A in a downtrodden healthcare space --Medicaid.
Government-sponsored programs like Medicaid and Medicare have traditionally been viewed as ho-hum businesses with razor-thin profit margins.
So why is WellPoint jumping with both feet into a business that is typically not a big money maker?
Let's take a closer look. . .
Insurers Eye Government Programs for Profits
Medicaid has a long history as a perpetual money pit, funded jointly by the states and federal government to assure healthcare for the needy.
But Medicaid spending currently takes up 24% of the average state's already strained budget and is growing at 7% a year.
In an effort to rein in spending, more and more beleaguered states have been turning to private managed care companies to run their publicly-funded healthcare programs like Medicaid.
But Obamacare promises to fundamentally alter the landscape by expanding Medicaid to cover more people.
In fact, when Obamacare kicks into high gear in 2014, a whopping 20 million (M) more individuals are likely to enter the Medicaid system. The $80B that states spend to outsource Medicaid could grow to $300B in five years, according to Barron's.
Overall Medicaid spending, which hit $457B this year, is expected to double by 2020.
None of this has been lost on the fat-cat insurance companies.
With that kind of money on the table, the biggest managed care companies are betting they can squeeze costs and maximize profits by sucking up companies already operating in the space.
But frankly, the writing has been on the wall for some time.
Most managed care companies have actually been reporting flat or shrinking membership in the private sector and healthy growth in public sectors for several years. And more and more small businesses are dropping coverage for their employees because of the high premiums insurers demand.
Simply put, big insurers have been moving away from private sector business because it's just not profitable enough.
The two largest managed care firms, UnitedHealth Group Inc. (UNH:NYSE) and WellPoint, are now big players in Medicare Advantage and Medicaid, according to The Huffington Post.
And with the impending influx from Obamacare, they plan to get even bigger.
With the Amerigroup purchase, WellPoint will gain 2M Medicaid members, spreading its footprint across 19 states and 4.5M accounts.
States Will Participate
One slightly overlooked aspect of the Supreme Court's ruling said that states could not be penalized for refusing to go along with the Medicaid expansion in 2014.
At least seven governors who fear their states won't be able to pay for it are concerned about the issue.
But in the long run, it's likely the states will go along because the law is laden with incentives to expand coverage.
You see, the federal government will pay for a full 100% of newly eligible Medicaid beneficiaries for the first three years of the expansion, and 90% of the cost after that until 2020.
"When you think about it that way, the Medicaid expansion sounds like a real win: States get loads of free money to pay their residents' health-care bills," wrote Sarah Kliff in a blog for The Washington Post.
Despite the states' misgivings, odds are when the Feds start doling out billions of dollars in 2014, the states will come around.
Healthcare Stocks: Who's Next in the M&A Game?
The Amerigroup deal has the industry buzzing about the next likely target.
"Expect other companies with government exposure to see greater investor interest," Credit Suisse AG (CS:ADR NYSE) analyst Charles Boorady wrote in a note to clients obtained by The Street.
Here are a few companies with significant public sector exposure that might be next in line.
Centene Corp. (CNC:NYSE): With over 2.1M members in 17 states, the company provides Medicaid and Medicaid-related health plan coverage to individuals through government subsidized programs, including Medicaid, foster care, and Medicare special needs plans. After slipping near its 52-week low on June 15, Centene has rebounded 30%.
WellCare Health Plans Inc. (WCG:NYSE): As of December 31, 2011, it provided approximately 2,562,000 members with prescription drug plans under the Medicare Part D program that offers prescription drug coverage to Medicare-eligible beneficiaries. WellCare has already started to expand its managed care presence. On July 18 it announced a deal with Humana Inc. (HUM:NYSE) to acquire select assets of Arcadian Health Plan Inc.'s Desert Canyon Community Care Medicare Advantage plans in Arizona. WellCare stock has soared 28% this year.
Healthnet Inc. (HNT:NYSE): Healthnet serves approximately 6M members in the United States through group, individual, Medicare, Medicaid, and Veterans Affairs programs including Medicare advantage plans. HNT stock is up 6% over the past month.