Aetna is in the midst of a split up, break up or sale of assets yet continues to sell for only 9x current EPS. The company competes in two basic businesses - Health Insurance and Financial Services. The financial services businesses are in good shape, growing at double digit rates with an ROE of more than 15%. These business are expected to generate $475 in after tax net income (before interest) this year and are rumored to fetch $9 billion from ING Group. This price would be in line with what ING paid for Reliastar. Even if the deal fell through, Aetna is in the process of spinning off the financial services businesses. A sale (to ING or someone else) would have to have superior after tax economics to a spin-off to make it worthwhile. It is our understanding that the company is considering ways to minimize or eliminate any taxes on a sale.
The remaining health care business would sell for roughly $5 billion (the market cap of $9.8 billion plus the debt of $4.2 billion less the $9 billion from the sale or spin-off of financial services). In 1999, the health care business earned $815 million after a corporate allocation and tax but before goodwill amortization and interest expense. During 2000, Aetna has to absorb the acquisition of Prudential Health Care which was acquired last September. While Prudential's business is money losing, Aetna intends to convert the Prudential membership to its own lower cost/higher priced system. This will undoubtedly cause membership to decline (I have assumed 25%). However, the turnaround will still add approximately $75 million to Aetna's earnings compared with 2000, even after eliminating the re-insurance support provided by Prudential this year. Furthermore, the HMO cycle appears to be turning with premium increases in the high single digits to low double digits more than offsetting rising medical costs. I expect Aetna's health care earnings to grow more than 10% per year form the 2000 base as Prudential gets fixed and the cycle turns.
If we use upside valuation parameters for the health care business - $890 million in adjusted income (with the Prudential turnaround) and the multiples afforded the other national health insurers (United Health Care and Cigna) - we arrive at a $10 billion after debt figure. The upside potentail, then is $134 per share ($9 billion from financial services and $10 billion from health care). With no success from Prudential, a multiple more in line with the regional HMO's, and a high tax penalty on the disposition of Financial Services, the low case valuation is roughly $68 per share. Thus, the downside appears to be minimal and the upside appears to be huge.
Impending break up / sale of company. Assimilation of Prudential acquisition. Turn around in HMO business.