UnitedHealth Group Inc (NYSE:UNH), the dominant player in the U.S. health insurance market, has agreed to buy the medical clinic business of Davita Inc (NYSE:DVA) for $4.9 billion, accelerating consolidation in the healthcare space. This could mean good things for UNH stock.
In describing the pending merger of CVS Health Corp (NYSE:CVS) and Aetna Inc (NYSE:AET), health insurers are looking to buy facilities and drug dispensing units so they can gain control over costs. You can’t have an unlimited draw from a limited pool.
The ObamaCare exchanges proved that what people want is managed care, not insurance in case they get sick but health management services. By owning Pharmacy Benefit Managers (PBMs) to bargain on drug prices, as well as medical facilities, insurers can gain better control over these costs.
A Look at UNH Stock
No company better illustrates the advantages of cost visibility than UnitedHealth. The Minnesota-based insurer has become the dominant firm in its industry, with a market cap of nearly $213 billion, against $58 billion for second-place Aetna.
The key to this is Optum, which former CEO Stephen Hemsley transformed into a dominant player in health IT. The key transformation was the 2015 acquisition of PBM Catamaran Corp (USA) for $12.8 billion, most of it borrowed money, which increased its bargaining power with drug companies.
The DaVita clinics, which include a half-dozen surgical centers, give it new cost visibility in delivering health care services. Since acquiring Catamaran, the value of both CVS and Express Scripts Holding Co. (NASDAQ:ESRX) have fallen by over 20% each, while UNH stock is up 80%.
The CVS acquisition of Aetna is designed to give it order flow from Aetna customers, along with policy cash it can use to expand its own MinuteClinics and possibly buy other facilities as well.
The success of the Catamaran deal, combined with CVS’ deal with Aetna, puts pressure on other insurance players and healthcare companies to seek partners and achieve vertical integration to control costs.
What form that may take is unclear, but there is a good model in Centene Corp. (NYSE:CNC), which has become a “10-bagger” since passage of the Affordable Care Act. Its market gap has grown by 1,000%, thanks to Medicare and Medicaid contracts it managed to service profitably by having control over costs.
Other companies that might want to make a deal include ExpressScripts and Rite Aid Corp. (NYSE:RAD), the small drug store chain that also has a PBM called EnvisionRX, or hospital chains such as Tenet Healthcare Corp. (NYSE:THC), which has a market cap of just $1.3 billion despite 2016 revenues of nearly $20 billion.
The Bottom Line on UNH Stock
What insurers can bring to facility managers is order flow that fills beds, while facilities can give insurers control over costs. The DaVita acquisition shows this is the direction the industry wants to take. The problem is that acquiring larger players, especially acute care hospitals, carries risks.
Hospitals are a little like hotels and airlines, in that beds that aren’t used are wasted money, and it can be hard to be certain how many beds may be needed at any one time. On the other hand, guaranteed order flow and cost control can make hospitals a gold mine. This puts UNH stock in a good position.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at email@example.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.