M&A Case
Transaction: Aetna / Humana
By A. A. OULDELALA
Important: The following case was analyzed in June 2016; that's why all events that occurred after are not considered.
Aetna and Humana, Two Health Care Insurer companies, under their respective Board members, decided to agree on a transaction of $37B to pay to Humana. If approved by regulations, this move will create the "largest Health Care Company for elderly" (Grover, Reuters, 2015).
1. Strategic Rationale for the Transaction
The transaction announced by July 3rd, 2015, is a straightforward acquisition. The acquiring shareholders will own 74% of the combined structure and will pay a premium of 29%.
Furthermore, the buyers provided clear and convincing strategic arguments: market share gain, geographic and product line expansions. Those factors will be reached by improving their membership position, commercial offer, and ability to size the government business. In contrast, although they proposed a premium of 29%, highlighted the potential synergy plan of $2.25B and a low double-digit of projected EPS accretion, they did not present the projected IRR. That is why the presentation lacked clarity on financial benefits.
In addition, all signals let think that they did not have to afford to let another party take on the business. As a matter of fact, in the proxy S4, we can read that they were in the race with two other companies due to the merger tendency in this industry. What's more, the macroeconomic reasons due to the Obama Care plan push Health Care companies to respond by an external growth rather than a slow organic one. Additionally, Humana presents a good fit for all strategic reasons shown above.
On the other hand, one of the weaknesses of the presentation is the financial benefits that would be generated. Even though they showed potential cost savings and a premium of 29%, they did not present clear short-term financial measures such as EPS accretion, the IRR, or the Pro-forma impact on Book Value. We also notice that neither the Added Market Value nor the Excess Total Return to Shareholders was articulated. Moreover, besides a vague sentence about potential shareholders' financial value creation, they did not present its magnitude. Therefore, this may lead to a certain apprehension.
Besides, one of the well-developed parts of the acquisition is risk aspects. As they may compromise the process, Human and Technology integrations were tackled as potential organizational risks. Rating grade, shareholder approval, and Antitrust risks were also explicitly identified. We observe that antitrust may be the biggest one. It was even stated that if Aetna can not obtain the regulator's authorizations, Humana must compensate by $1B.
2. Terms of the Transaction
The price is more convenient for the seller than for the buyer. Indeed, the price of $39B seems to be fair for both advisor parties. And compared to premiums that the industry has held since 2002 for comparable transactions (9.4% to 43%), this one is in between. But, first, they did not mention the magnitude of the IRR. Second, they did not show the combined projections. Third, they lacked direct comparable. And finally, they faced pressure caused by the presence of other buyers. We can infer that Aetna overpaid the deal thanks to all these elements. Analysts estimated the IRR was 12.2% (Nyitray, marketrealist.com, 2015). Thus, given a WACC of 8%, the spread of 4.2% indicates a higher risk. That said, despite the lack of direct comparable, advisors conducted multiple comparable valuations using current and prior acquisitions and a cash flow discount that relatively led to the same price range.
The Aetna executives' decision-making process may have been shaped by confirmation bias and overconfidence bias due to their successful prior acquisition of Coventry in 2013.
On the social matter, Aetna presented a well-articulated change management plan. They paid particular attention to attracting, retaining, and motivating key executives by harmonizing practices and compensation programs and putting a Transition Team of 6 members from both companies. In addition, they will expand their board by four chairs to Humana board members.
However, to finance the transaction, Aetna must leverage $16B, an additional debt that increases its financial risk substantially. Their debt-to-Equity ratio will increase from 34% to 46%. Consequently, they have planned to reduce this ratio by 6 points within the first two years. What's more, due to this exposition, Moody's downgraded Aetna's debt rating from Baa1 to Baa2 (Singer, Courant.com, 2016).
3. The Process and Market Reaction
As explained above, due to macroeconomic factors (The Obama Care) and industry landscape changes (Consolidation trend), the process was a competitive one, especially in the final stage (Farrell, WSJ, 2015). They were competing against two other bidders because this acquisition would create the third-biggest health insurer in the market. This race may be behind what the market considers as an irrational and an overpaid transaction given to the poor performance on the net profit of Humana during last year. After the acquisition announcement, Aetna's share price dropped by 9.3 points (Patrick, marketrealist.com, 2015).
In connection to the negotiations process, it is stated in Proxy S4 that all discussions with a third party are open until the approval of the acquisition by shareholders of both companies. Furthermore, Aetna imposes a fee of $1.314b to Humana if it withdraws or does not respect a non-solicitation agreement.
Additionally, Humana's shareholders will secure a premium of 29% in an uncertain future for their company's business and share price (see figure 1).
Consequently, shareholders of both companies approved the transaction for the same reasons presented, Humana because of the premium, and Aetna because of the potential oligopoly position on the market.
To sum up, this acquisition has a lot to do with the strategic factors that represent the transaction's rational motivation. Despite this, its lack of discipline and the apparent irrationality of Aetna's executives make potential financial benefits less likely to happen and make the market reaction more appropriate.
Figure 1: 3 Days after the acquisition announcement, both Aetna and Humana share prices dropped dramatically. Source, marketrealist.com, 2015.
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