Wednesday, December 06, 2006

Back to Healthcare

When we sold United Healthcare (UNH) a few weeks ago, we did so with the intention of replacing it with something else from the Healthcare sector. We believe this is a thriving industry with good overall Return on Capital characteristics and the opportunity for continued future consolidation.

After a thorough look, we decided to take a position early last week in WellPoint Inc. (WLP), a “best-of-breed” health insurance provider and one of UNH’s primary competitors. WellPoint is the leading health benefits company in terms of membership in the United States and is an independent licensee of the Blue Cross Blue Shield Association, providing Blue Cross coverage in 14 states, including California, Colorado, Connecticut, Georgia, Indiana, Kentucky, Maine, Missouri, New Hampshire, New York (primarily NYC), Ohio, Virginia and Wisconsin. The company provides coverage as UniCare in several other states. It is also one of the largest Medicare providers and the largest Medicaid provider in the country.

WellPoint also extends managed care plans to the large and small employer, individual, and senior markets. In addition, managed care services are provided to self-funded customers, including claims processing, underwriting, actuarial services, medical cost management and other administrative services. Other specialty services include pharmacy benefit management, group life and disability insurance, dental, vision, behavioral health, workers compensation and long-term care insurance.

WellPoint nicely meets our investment criteria for both EVA and valuation. Twelve-month expectations from the analysts we follow range from $78 by Goldman to $93 by Bear Stearns. Our model confirms a valuation somewhere in the middle of that range. We see this as a low-risk holding with significant upside over the next few years, and a good replacement for UNH.

We would like to take a position in one more Healthcare related company to participate in further consolidation and the growth evident in some of the mid-sized carriers. Healthcare stocks have substantially underperformed the S&P 500 this year and we would expect to see better performance in the near term. Most of this underperformance relates to the sell off in the weeks prior to the election, as the markets discounted the possible change in legislation from a shift in control in the Congress. Even though Medicare Advantage will likely be scrutinized, significant change is unlikely, especially in the next two years. Certain issues such as private fee for service (PFFS) plans are likely to receive most of the attention, but this is a smaller growth component for such companies as WLP. We feel comfortable that the returns on investment and growth incentives for healthcare companies will remain attractive, as the US population ages and innovative products for the uninsured become a focus for the private sector.

As always we welcome your comments.

Peter & Jack Falker

Note: At the time of publication, neither Jack nor Peter Falker, nor the clients of FalkerInvestments Inc. had any positions in UNH.

Note: At the time of publication Jack and Peter Falker and the clients of FalkerInvestments Inc. had positions in WLP.