Dealtalk: Aetna-Cigna deal? Obstacles yes, but benefits too

NEW YORK Thu Jul 14, 2011 5:56pm EDT

Mark Bertolini, President of Aetna, speaks at the Reuters Health Summit in New York, November 10, 2010. REUTERS/Brendan McDermid

Mark Bertolini, President of Aetna, speaks at the Reuters Health Summit in New York, November 10, 2010.

Credit: Reuters/Brendan McDermid

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NEW YORK (Reuters) - They were just a few brief comments at an investor conference but they were enough to set the health insurance industry abuzz: Could Aetna buy Cigna?

The mention of a deal that would merge two of the biggest U.S. health insurers and could be worth $16 billion has Wall Street talking about its logic and whether the Obama administration and other regulators would even allow it.

Large-scale dealmaking in the managed care sector has been virtually nonexistent in the past five years, in part because few were willing to make a major bet on the industry's future while the government debated new regulations.

With the healthcare overhaul in place, companies are striking some relatively small acquisitions to increase market share or add capabilities in areas such as technology. But there have been no recent transactions even remotely close in size to a possible merger between Aetna Inc (AET.N) and Cigna Corp. (CI.N)

Yet such a deal has some clear appeal: The combined company would add scale at a time when size is at a premium; allow for significant cost savings and other efficiencies; and create a huge player in areas including international and life insurance and disability benefits.

"There are a lot of good business reasons for it but I think it might be difficult to execute that politically," said Brad Fluegel, a former top strategy executive at WellPoint Inc (WLP.N) and Aetna. "Such a transaction, if it were to be contemplated, would face a lot of political and regulatory scrutiny."

(For a graphic on biggest health insurer deals since 2000, see: r.reuters.com/kaq62s )

The speculation stems from a Sanford Bernstein investor conference last month, when Cigna Chief Executive David Cordani was asked during a presentation specifically about an acquisition by Aetna.

Rather than brush off the question, as companies tend to do when queried about possible deals, Cordani discussed the topic briefly. He acknowledged similarities between the two companies and the possible economies of scale of such a combination. He said it would be inappropriate for any company to rule out alternatives, but noted that Cigna already had a means to increase shareholder value on its own.

"People certainly paid attention to the fact that he didn't give a dismissive answer," Jefferies & Co analyst David Windley said.

A Cigna spokeswoman declined to comment. An Aetna spokesman said it does not comment on rumors or speculation.

TIER TWO PLAYERS

Shares of Cigna have risen more than 4 percent since the Bernstein conference compared with a rise of more than 2 percent for the S&P Managed Healthcare index of large insurers .GSPHMO.

The combination would create the second-largest health plan in the commercial market serving employers, according to Barclays Capital analyst Joshua Raskin, who issued a 26-page analysis of the potential combination after Cordani's remarks.

As it stands, Aetna and Cigna are the No. 3 and 4 players, respectively, in the national commercial market, but they significantly trail leaders WellPoint Inc (WLP.N) and UnitedHealth Group (UNH.N), according to Barclays.

"These are two very different and very capable companies, and they're both playing at the second tier," said Dan Mendelson, CEO of Avalere Health, a research and strategic advisory firm.

The merger of two widely known insurance brands would have an estimated commercial membership of about 27 million people, gaining more power in negotiating rates with providers. The combined company could also wring out huge savings from cutting overlapping functions.

The U.S. health overhaul also gives incentive to insurers to grow larger, Windley said. New regulations target how much the companies must spend on medical costs, potentially pinching their profit margins.

"The unintended consequence from the government's viewpoint of reform is that bigger is better," Windley said. "If margins are limited, and you make your profit by leveraging your overhead, then more members and more premium revenue running across that overhead is better."

Takeover premiums in the industry hover on average at around 15 to 20 percent, according to Barclays' Raskin. That would peg a purchase of Cigna, which has a market value of about $13.8 billion, at $15.9 billion to $16.6 billion. Aetna's market value stands at about $16.5 billion.

One healthcare banker, speaking generally about large-scale mergers in managed care, said pent up demand exists for a deal and that the overhang of healthcare reform has waned. But the banker, who declined to be named, did not see any such deals on the horizon in the next three to six months.

To have enough time to fully integrate before the main planks of the U.S. health overhaul are implemented in January 2014, Raskin said that an Aetna-Cigna deal would need to be announced by the end of this year.

Just this week, Cigna added a little spice to the deal chatter by announcing it was moving its headquarters from Philadelphia to Bloomfield, Connecticut -- putting it about 7 miles from Aetna's home base in Hartford.

REASONS TO BE SKEPTICAL

There are reasons to be skeptical of a deal. Both Cordani and Aetna CEO Mark Bertolini, a former Cigna executive, are relatively new to their posts and may be reluctant to cede power.

Neither company is a leader in government health programs -- Medicare plans for the elderly and Medicaid plans for low-income Americans -- which are likely growth areas for the industry, so a deal would not help in these markets.

Also, doubts remain about whether insurers should be investing significantly in their traditional business of employer-based healthcare when it is becoming more regulated, and instead should be diversifying more.

Windley put the odds of the deal happening at about 25 percent.

The greatest obstacle may be political. Democratic lawmakers were eager to attack health insurers during the overhaul debate. Regulators on the federal and state level would be unlikely to let such a deal skate through without significant scrutiny.

"It would come with an awful lot of suffering," said Fluegel, now an executive-in-residence at healthcare private equity firm Health Evolution Partners. "It might make enough sense to warrant that, but it would not be easy."

(Reporting by Lewis Krauskopf; additional reporting by Jessica Hall in Philadelphia, editing by Matthew Lewis)

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