Triple-S Management Corp GTS
December 31, 2008 - 11:05am EST by
jwilliam903
2008 2009
Price: 12.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 384 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

GTS is the exclusive Blue Shield licensee and largest managed care company in Puerto Rico. This idea was written up roughly a year ago by jigsaw702. I highly recommend reading the prior writeup as it does a good job of laying out the history and investment thesis for this company. I will try to lay out an updated rationale for why we think GTS is a highly compelling investment opportunity today.

Thesis: The GTS thesis is simple … earnings growth + multiple expansion + takeover potential will lead to a stock price at least 2 – 3x current levels.

Earnings Growth:

GTS is on track to earn roughly $1.80 for 2008. Through a combination of organic growth, accretion from acquisitions, and accretion from stock-buybacks, GTS’s earnings will exceed $3 over the next few years.

Organic growth: The main avenue of organic growth for GTS is through cost-cutting initiatives on its medical loss ratio (MLR). The MLR is basically COGS as a % of revenue. GTS’s commercial MLR is currently in the 86% range (87% for 2008 full-year basis). Most other HMOs have commercial MLRs in the low 80% range. The main cause for GTS’s discrepancy is that up until a year or two ago, GTS was a non-profit company. Not only was it non-profit, but prior to the IPO, GTS was owned by the doctors who provided medical service to its customers (i.e., the same doctors who represent the COGS in the MLR). No incentive existed to contain costs or manage MLR. Since the IPO, GTS has already lowered its commercial MLR from 88% to 86%. We believe that GTS can conservatively lower its combined MLR by an additional 200 – 300 bps over the next couple years through its new-found focus on cost containment. With roughly $1.7B of medical premiums (assumes mid-single digit premium growth from today’s $1.5B level over a couple years), that MLR improvement would equate to $0.65 - $0.95 in incremental EPS (assuming 40% tax-rate and 32mm shares).

Acquisitions: GTS has announced that they will be acquiring La Cruz Azul, the Blue Cross entity in Puerto Rico. By so doing, GTS will consolidate the Blue Cross / Blue Shield names, as well as gain incremental members onto its network. While the company has not yet disclosed the purchase price for LCA, we think it is a very low number (i.e., $20mm or less). In terms of earnings accretion, GTS will be acquiring roughly $80mm of medical premium that is currently operating at an 85% MLR. With no incremental operating costs (best case scenario), GTS would pick up $12mm of incremental EBT, or $0.22 per share of EPS (assuming 40% tax-rate and 32mm shares). If GTS has to incur operating costs at its current 10% expense ratio (i.e., no operating leverage in the model … worst case scenario), the EPS accretion would be $0.08. There is also an additional $0.05 - $0.10 that will come from LCA’s ASO business. The “financing cost” of a $20mm purchase price would be about a penny a share. Net, net … GTS will likely pickup roughly $0.15 to $0.30 from the LCA acquisition. 

 For those doing the math at home, we’re up to $0.80 - $1.25 in incremental EPS from organic growth + announced acquisition, or $2.60 - $3.05 of total EPS.

Buyback: GTS has announced, and is already executing, a $40mm stock buyback. This is 10%+ of the current market cap. Depending on where earnings ultimately end up, the buyback will likely add $0.25 to $0.30 of accretion.

Including the buyback, we get EPS in the $2.85 - $3.35 zone. Let’s call it $3 to have a round number.

Multiple Expansion:

On current earnings, GTS is trading at a 6.7x P/E. A couple years from now, the P/E will decline to +/- 4x. We think these multiples are too low for a solidly profitable, over-capitalized HMO. Currently, all of the HMOs are trading at low multiples (e.g., 8 – 9x P/Es for WLP, UNH, AET). The entire industry was significantly hit in 2008 as almost every company in the space had to take down numbers due to mis-estimating rising cost trends in the back half of 2007 or 1st half of 2008. Additionally, there is the cloud of political change overhanging the group. However, we believe over time multiples for the group will revert to the historic 10 – 15x range. Using 10x P/E for GTS would result in a $30+ stock.

One can also look at GTS on a book value basis. Currently, GTS is trading ~ 0.8x BV (vs. 1.0 – 1.5 for WLP, UNH and AET). Adding roughly $7 of EPS over the next three years to GTS’s current BV and using a 1.25x multiple yields a $27.50 stock.

Assuming HMOs get their cost estimates right (which you know within 12 months of them making the estimate due to the short-tail nature of health insurance), quality of earnings is generally very good with cash flow typically equaling net income. Thinking about multiple on a FCF basis, we think a 25% FCF yield is excessive, and that something more like a 10% yield over time (i.e., 10x P/E multiple) is not at all unreasonable. 

Two other quick points: GTS guide-down and over-capitalization. While GTS also had a minor guide-down earlier in the year … 8% or so on EPS … their guide-down was entirely limited to the Medicare portion of their business. In GTS’s core commercial business it actually exceeded initial forecast. This made GTS the ONLY company in the sector to meet, let alone exceed, forecast for commercial business. We believe this is indicative of the fact that the Puerto Rican commercial medical business is not experiencing the same cost pressure trends that mainland carriers are seeing.

Re: over-capitalization … GTS has significant excess capital. Admittedly, this partially stems from the fact that Puerto Rico has very low statutory capital requirements. Nevertheless, that is the regulatory regime under which GTS operates. Prior to the start of the buyback, GTS had over $6 a share of excess capital at its statutory subs. Additionally, there is excess cash at the holding company. To be clear, management has no intention of running their business at the minimum statuory capital level.   Nevertheless, the magnitude of excess capital relative to current stock price gives some indication of the financial flexibility embedded in GTS’s balance sheet.

Takeover Potential:

As jigsaw702 pointed out in last year’s writeup, of the 6 public Blue-Cross/Blue-Shield companies that once existed, all but one (WLP) have been acquired. We see no reason why WLP will not ultimately acquire GTS. Why? HMO’s are a scale business. Adding incremental lives to one’s platform can be highly accretive. Expanding WLP’s footprint of BC/BS companies is a great way for it to use its prodigious cash flow in a highly accretive manner. Prior acquisitions in the space were done at high-teens P/E multiples. Even a multiple at half that level would result in a double.

Catalyst

- Further improvement in MLR
- Completion of LCA acquisition
- Completion of announced buyback
- Ultimate sale to WLP
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