As the old saw on Wall Street goes, pigs get fed and hogs get slaughtered. That adage might apply to Humana Inc (NYSE:HUM) stock at this point. Humana stock has gained 259% in the past five years. HUM stock trades just off an all-time high at the moment, thanks to recent bullish speculation.
That speculation centers on a potential acquisition of Humana by Walmart Inc (NYSE:WMT). In the wake of consolidation in the healthcare space, and with the threat of Amazon.com, Inc. (NASDAQ:AMZN) hanging over the industry, such a deal makes some sense. Humana shareholders would get a likely premium to the current share price.
Walmart would get a base of new customers for its pharmacy and in-store clinics, while adding to the scale seemingly needed to compete in the modern healthcare space.
Such a deal could provide more upside for Humana stock, even after the torrid run of the past few years. But the key word there is “could.” An outright acquisition isn’t guaranteed.
Nor is it a slam dunk that such a deal would be approved. With HUM stock again nearing $300, there’s a case that upside at this point is limited and that it might be time to take profits rather than squeezing out a few more points of gains.
Walmart and Humana
HUM stock gained 4.4%, after being up as much as 8%, on March 29, after the Wall Street Journal first reported talks between Humana and Walmart. And a Humana acquisition makes some sense. CVS Health Corp (NYSE:CVS) is purchasing Aetna Inc (NYSE:AET).
Insurer Cigna Corporation (NYSE:CI) is taking out pharmacy benefits manager Express Scripts Holding Co (NASDAQ:ESRX). Amazon, Berkshire Hathaway Inc. (NYSE:BRK.A,BRK.B), and JPMorgan Chase & Co. (NYSE:JPM) are teaming up in an initiative to reduce costs for their own employees.
It’s a “get big or go home” environment right now. These vertical mergers will create scale, drive synergies and negotiating power, and allow for more cross-selling. Controlling costs remains the key goal in the industry. Unsurprisingly, that focus has led to the wave of consolidation that very well may sweep up Humana as well.
All that said, it’s far too early to treat a WMT-HUM tie-up as a fait accompli. Both the Journal and Bloomberg have reported that other options are being discussed. A Humana takeout would be Walmart’s largest deal ever – by far.
So it’s unwise to treat HUM stock as a merger arbitrage play at this point. And the question for Humana stock is how much upside there really is even if a deal is announced.
What Is HUM Stock Worth In a Buyout?
As noted, Humana stock already has more than tripled in the last five years. And so it may be difficult for Walmart to stomach much more of a premium to the current price.
One analyst, as noted by Barron’s, cited a likely price of $360 per share. Using the 11x+ EV/EBITDA multiple implied in the CVS-Aetna deal (based on the price of CVS stock at the time) would suggest a similar range of about $350-$375 per share for Humana stock (depending in part on whether WMT uses 2017 or 2018 figures).
That’s about a 20-30% premium to the current price – in the ballpark of what’s normally seen in M&A situations. But if Walmart chooses to pay in cash rather than in stock, that may come down a bit. 25% above the price seen before the recent rumors (the figure often used in these types of deals) suggests something closer to $340.
Still, that provides relatively significant upside for Humana stock. But there’s a catch.
The Risks to Humana Stock
HUM stock isn’t going to trade up to meet the offer price. The antitrust environment is more uncertain and more unclear, even for these vertical combinations. It will take at least a few quarters for the deal to close. Humana stock isn’t going to trade at the offer price or close to it.
Indeed, Aetna shares trade at a 15% discount to the current value of the CVS offer. If a similar discount were applied to Humana, HUM stock would move to $300-$320 if an offer were announced, and accepted.
On the low end, that’s less than 5% upside from current levels. And – again – a Walmart takeover is not necessarily a likely outcome. Meanwhile, long-term concerns surround the space, and Humana very well could struggle if it doesn’t sell itself and has to face larger, more diversified competitors.
And on its own, Humana stock no longer looks that cheap. HUM trades at over 20x the midpoint of 2018 guidance. Rivals like Cigna and Anthem Inc (NYSE:ANTM) are in the mid-teens.
Either way, then, it looks like upside is relatively capped for HUM stock in the near term. And investors looking to squeeze out more gains after a torrid run are taking risks to do so. The Walmart deal could fall through. The earnings multiple could compress. Or the ever-volatile political environment could add pressure. Without a path to real upside in the near term, it’s simply no longer worth taking on those risks.
As of this writing, Vince Martin has no positions in any securities mentioned.