CHICAGO (Reuters) - Health insurer Aetna Inc said on Monday that it would buy rival Coventry Health Care Inc for $5.6 billion to increase its share of the fast-growing, U.S. government-backed Medicare and Medicaid programs.
The purchase, which will add more than 5 million members to Aetna's customer ranks and double its business administering the government's Medicaid health plan for the poor, comes just weeks after rival WellPoint Inc struck a deal to buy Medicaid specialist Amerigroup Corp.
"It's about scale — getting critical mass in Medicare and Medicaid, gaining negotiating power with hospitals and other providers," said Jeff Jonas, an analyst with Gabelli Health and Wellness Trust Mutual Fund. "After several other well-received deals ... Aetna was getting left behind as one of the smaller players. Not anymore."
Bankers and investors see the wave of health insurer consolidation accelerating further as the United States moves to implement President Barack Obama's healthcare overhaul.
But the law still faces significant challenges. Republican presidential candidate Mitt Romney has vowed to roll back the Affordable Care Act if elected in November, and Republican state leaders could make it difficult to implement many provisions of the law.
The U.S. health reform law aims to expand coverage to 16 million more Americans through privately run insurance exchanges in each state and extend Medicaid eligibility to an additional 16 million people by raising limits on household income.
"The transaction boosts Aetna's footprint in government programs, and adds scale to its commercial operations, which we view as strategically important ahead of the expected implementation of exchanges and health reform starting in 2014," Barclays analysts said in a note to clients.
Aetna, the third-largest U.S. health insurer, will pay about $42.08 per share - $27.30 in cash and 0.3885 of its common shares. That is a 20.4 percent premium over Coventry's closing stock price of $34.94 on Friday.
Aetna Chief Executive Mark Bertolini estimated the combined company's 2012 revenue at $50 billion. The deal, expected to close in mid-2013, will add nearly 4 million medical members and 1.5 million members of Medicare Part D, which reduces prescription drug costs in the government plan for the elderly.
Aetna shares closed up 5.6 percent and Coventry gained 20.3 percent on the New York Stock Exchange.
Chief Financial Officer Joseph Zubretsky said there was enough opportunity in managing government health plans, even without the overhaul. Aetna's government business will account for more than 30 percent of revenue after the deal, up from 23 percent currently.
"The election and SCOTUS were not critical to our strategic thinking," he said in an interview, referring to the U.S. Supreme Court's June decision to uphold the "individual mandate" requiring that most Americans obtain health insurance by 2014 or pay a tax. "We think we had a very good opportunity to gain better access to government-based revenues at valuations that were very reasonable."
If Romney did win the White House and overturned the healthcare law, Jonas said, Republicans' proposed changes to the system would also mean plenty of business for insurers.
"The need for scale doesn't change," he said. "We see that with hospitals and physicians merging into bigger chains as well as the insurers."
The deal should also help Aetna wield even more influence on health policy in Washington. The Hartford, Connecticut, company spent nearly $4 million to defend its interests in Congress last year, and $2.1 million during the first six months of 2012, according to U.S. Senate records. Coventry spent $300,000 on lobbyists over the same 18-month period.
Their combined lobbying would place them among the U.S. insurance industry's top 10 spenders, according to the nonprofit Center for Responsive Politics.
Zubretsky said he expects the recent wave of M&A activity to continue in the health insurance sector and that Aetna would still have the cash flow for "small discrete transactions."
"The game board is getting a little thin," he said. "There has been a lot of consolidation recently and I see no reason why there wouldn't be more."
In July, WellPoint said it would buy rival Amerigroup for $4.46 billion, nearly doubling its Medicaid business. Last October, Cigna Corp agreed to buy HealthSpring Inc for $3.8 billion to strengthen its Medicare business.
Gabelli's Jonas noted market speculation that Humana Inc might do a deal, saying that it is strong in Medicare but fairly small in Medicaid and employer-provided insurance.
"UnitedHealth could easily afford an acquisition but they have such scale and capability in all areas that they don't need to do anything," he said.
Including the assumption of Coventry debt, the transaction is valued at $7.3 billion, the companies said. Aetna plans to issue $2.5 billion in new debt and commercial paper to help finance the deal but does not expect any impact on credit ratings.
Zubretsky affirmed Aetna's financial forecasts for the year but said they also reflected the fact that the deal would reduce the company's ability to buy back shares for the rest of 2012.
Aetna said it expects the deal to add modestly to operating earnings per share in 2013, 45 cents per share in 2014 and 90 cents per share in 2015.
Aetna's financial advisers were Goldman Sachs and UBS Investment Bank, while Davis Polk & Wardwell LLP and Jones Day served as legal advisers. Coventry's financial adviser was Greenhill and Co, and it received legal advice from Wachtell, Lipton, Rosen & Katz; Bass, Berry & Sims PLC; and Crowell & Moring LLP.
Additional reporting by Adithya Venkatesan and Anil D'Silva in Bangalore, David Morgan in Washington; editing by Michele Gershberg, Matthew Lewis and M.D. Golan