A Union In The Making?

The healthcare market was recently abuzz with the news of a potential mega-merger that sent shares of Humana (HUM) and The Cigna Group (CI) into a nosedive - 5.5% and 8.1% respectively. This news, centered around a transaction combining stocks and cash, could significantly reshape the healthcare landscape.

But let's not get ahead of ourselves. After all, in the world of healthcare mergers, certainty is as elusive as a mirage.

Still, if you’re feeling a sense of déjà vu, it’s because this isn’t the first time Humana and Cigna have danced around the idea of a merger.

Recall 2015 when Humana flirted with the idea of a merger with Cigna but ended up cozying up to Aetna (AET) – a union that never saw the light of day, thanks to the US courts.

A similar fate befell an attempted merger in 2017, when Elevance Health (ELV), then known as Anthem, tried to acquire Cigna for $48 billion, only to be blocked by the courts.

Since these previous attempts, both Humana and Cigna have significantly grown.

Prior to this market shake-up, Humana boasted a market capitalization of $62.87 billion, with Cigna commanding a higher ground at $83.77 billion.

But as history shows, regulatory skepticism often casts a long shadow over such ambitious plans, with fears of increased costs for the American public. This skepticism has extended to smaller deals, such as UnitedHealth Group's (UNH), which faced hurdles in their acquisition attempts.

Yet, the potential merger between these healthcare giants teases the possibility of substantial cost savings.

When giants unite, the promise of cost savings looms large. Redundancies in corporate functions like HR, investor relations, and executive positions offer low-hanging fruits for cost-cutting.

But the real cherry on top is the potential for operational synergies – cross-selling opportunities and leveraging infrastructure for efficient service delivery.

Humana's stronghold lies in its Insurance unit and CenterWell, with the latter, including pharmacy, provider services, and home solutions, contributing 16.3% of last year's revenue.

In contrast, Cigna wades into deeper waters, with its substantial revenue streams from pharmacy benefits and home delivery pharmacy businesses.

Now, let’s look at the companies in terms of revenue. A side-by-side of Humana and Cigna's revenues offers an intriguing picture.

Humana's Medicare Advantage revenues soared from $59.47 billion in 2020 to $72.89 billion in 2022.

Cigna, however, has only inched forward in this space. Humana's evident dominance in Medicare Advantage, with a market share of about 18%, contrasts sharply with Cigna's modest 2%.

Despite these differences, a merger isn't outside the realm of possibility.

For example, CVS (CVS) managed to successfully acquire Aetna for $69 billion back in 2018, with the two companies eventually turning into CVS Health.

While that merger proved that big deals could happen, the odds for Humana-Cigna are not exactly in Vegas betting territory.

Speculations about Cigna offloading its Medicare Advantage operations could make this merger more palatable to regulators, but it's far from a sure bet.

Another question to think about amidst these talks is why the market reacted like someone yelled “fire” in a crowded theater.

Well, it all boils down to the fear of overpayment.

Cigna, being larger, could potentially swallow Humana. But Humana, with its stronger financial health and market positioning, is seen as the more desirable entity.

The valuation metrics – price to earnings, price to adjusted operating cash flow, and EV to EBITDA – further complicate this perception, as Humana commands a premium.

With a potential merger announcement might be on the horizon, investors should approach this with a blend of skepticism and intrigue. The market is jittery, perceiving a possible merger as potentially detrimental to shareholder value.

However, should the merger succeed against the odds, the combined prowess of Humana and Cigna could spell a profitable future for investors. Knowing that the healthcare sector is never short of surprises, this potential merger, should it come to pass, could be one for the history books.