WELLPOINT,INC.
Current Price: $35.60 (as of 11/28/08)
Ticker: WLP
Target Price: $49.75
Recommendation: Buy
Analyst Information:
Name: Robert Lazarony
Email:Lazarony.3@osu.edu
Phone: (216)272-7421
Advisor: Chris Henneforth, CFA
Fund: SIM (Bus-Fin 724)
Recommendation Summary:
•
•
•
•
•
Stock Information:
WellPoint is well positioned within the
industry, holding the largest customer base of
any managed care organization in the nation.
Demographic trends show increases in both
population age and obesity-this can be looked at
as both a positive and a negative:
o Increase in the amount of citizens who
will need healthcare coverage
o Significant cost restructuring could come
as a result, as medical costs will
increase due to complex treatments
required
The Managed care industry has not performed well
during the past year due to premium mispricing
and the economic slowdown.
However, it appears that the stock has been
oversold, and it should recover.
Both DCF and Multiples valuation show
significant upside potential (~40%) for
WellPoint over the next year.
Sector: Healthcare
Industry: Managed Care
Market Cap: 17.62 B
52 Wk High: 90.00
52 Wk Low: 27.50
Shares Outstanding: 509.04M
Earnings per Share: 5.61
P/E Ratio: 6.17
Beta: 1.14
Comparable Returns:
March
falloff from
premium
mispricing
FISHER
COLLEGE OF BUSINESS
Student Investment Management
Last Update November 28, 2008
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Table of Contents
Company Overview ........................................................................................................................ 3 Reportable Segments ...................................................................................................................... 3 Competitive Advantages ................................................................................................................. 4 Economic/Macro Analysis ............................................................................................................... 6 Sector/Industry Analysis ................................................................................................................. 9 Company Position within Industry ................................................................................................ 10 Growth Factors ............................................................................................................................. 11 New Product Offerings: ......................................................................................................... 11 Acquisitions: .......................................................................................................................... 12 Risk Factors ................................................................................................................................... 12 Economic Concerns: .............................................................................................................. 12 Competitive Forces: ............................................................................................................... 13 Regulation Uncertainty: ......................................................................................................... 14 Financials ....................................................................................................................................... 15 Income Statement: ................................................................................................................ 15 Balance Sheet: ....................................................................................................................... 15 Statement of Cash Flows: ...................................................................................................... 16 DCF Analysis: .......................................................................................................................... 16 Valuation Analysis ......................................................................................................................... 17 Absolute Valuation: ............................................................................................................... 17 Relative to S&P 500: .............................................................................................................. 18 Relative to Healthcare Sector: ............................................................................................... 19 Recommendation .......................................................................................................................... 19 DCF Spreadsheet ........................................................................................................................... 21 Consolidated Financial Statements for WellPoint, Inc. ................................................................ 22 Balance Sheet: ....................................................................................................................... 22 Income Statement: ................................................................................................................ 24 Endnotes: ...................................................................................................................................... 25 Student Investment Management: WellPoint, Inc.
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Company Overview1
WellPoint, Inc. is the largest health benefits company in terms of commercial membership
in the United States, serving 34.8 million medical members as of December 31, 2007. It is an
independent licensee of the Blue Cross and Blue Shield Association, or BCBSA, an association
of independent health benefit plans. WellPoint serves its members as the Blue Cross licensee for
California and as the Blue Cross and Blue Shield, or BCBS, licensee for: Colorado, Connecticut,
Georgia, Indiana, Kentucky, Maine, Missouri (excluding 30 counties in the Kansas City area),
Nevada, New Hampshire, New York (as BCBS in 10 New York city metropolitan and
surrounding counties, and as Blue Cross or BCBS in selected upstate counties only), Ohio,
Virginia (excluding the Northern Virginia suburbs of Washington, D.C.), and Wisconsin. It also
serves its members throughout the country as UniCare. It is licensed to conduct insurance
operations in all 50 states through its subsidiaries.
WellPoint offers a broad spectrum of network-based managed care plans to the large and
small employer, individual, Medicaid and senior markets. Their managed care plans include
preferred provider organizations, or PPOs; health maintenance organizations, or HMOs; pointof-service plans, or POS plans; traditional indemnity plans and other hybrid plans, including
consumer-driven health plans, or CDHPs; hospital only and limited benefit products. In addition,
WellPoint provides a broad array of managed care services to self-funded customers, including
claims processing, underwriting, stop loss insurance, actuarial services, provider network access,
medical cost management and other administrative services. The firm also provides an array of
specialty and other products and services including life and disability insurance benefits,
pharmacy benefit management, or PBM, specialty pharmacy, dental, vision, behavioral health
benefit services, long-term care insurance and flexible spending accounts.
Reportable Segments2
In the first quarter of 2008 WellPoint decided to reclassify their reportable segments.
WellPoint seems to do this quite frequently. However, to avoid any confusion, and because the
DCF analysis contained in this report uses 2007 segments, all segment information in this report
will be based on the reportable segments listed in WellPoint’s 2007 Form 10-K. Through
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December 31, 2007 WellPoint ran its business through three reportable segments: Consumer and
Commercial Business (CCB); Specialty, Senior and State Sponsored Business (4SB); and Other.
Consumer and Commercial Business:
The CCB segment is comprised of a collection of business units which offer similar
products and services, including commercial accounts and individual plans. The products
offered include a diversified mix of managed care options including PPOs, HMOs, traditional
indemnity benefits and POS plans. The segment also features some hybrid plans such as CDHPs,
hospital only and limited benefit products and covers additional managed care services.
Specialty, Senior and State Sponsored Business:
The 4SB segment mainly consists of business providing various health and specialty
products and services such as Medicare Part D, Medicare Advantage, Medicare Supplement,
Medicaid, life and disability insurance benefits, PBM, specialty pharmacy, dental, vision,
behavioral health benefit services and long-term care insurance. 4SB also offers some services
to workers compensation carriers.
Other:
The Other segment includes WellPoint’s Federal Government Solutions (FGS) business
as well as any other businesses that do not exceed the qualifications for a reportable segment
according to Statement of Financial Accounting Standards No. 131. Additionally, intersegment
sales and expense eliminations and corporate expenses not appearing in other segments are
reported here.
Competitive Advantages3
WellPoint has a number of sustainable competitive advantages that sets it apart from
other managed care organizations (MCO’s):
Enormous Customer Base:
The sheer number of members that WellPoint has can definitely be classified as one of its
greatest strengths. For a managed care organization to be successful, it must pool a large amount
of premiums and organize these into an efficient operating structure. The more market
penetration a firm has the easier it is for them to maintain this efficiency. With over 35 million
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customers, WellPoint is the biggest managed care organization in the nation from a membership
standpoint, and is well-positioned to offer a broad range of health benefits to its customers on a
more cost effective basis than many of its smaller competitors.
Blue Cross Blue Shield License:
WellPoint believes that one of its greatest strength is its ability market products under the
Blue Cross Blue Shield brand, the most recognized brand in the managed care industry. In
addition to being the most renowned, BCBS brands are the oldest and largest organization of
health benefits companies in the US. According to its website, about one in every three insured
Americans is covered by a Blue plan. WellPoint is the licensee to the BCBS brand in 14 states,
including California, New York, Ohio and Virginia. Obviously, being partnered with BCBS has
enabled WellPoint to become a force in the managed care industry, as seen by its massive
enrollment. If WellPoint continues to remain a licensee to the BCBS brand it will maintain its
position as a one of the nation’s top providers.
Broad Product Array:
The importance of having various products available cannot be understated in the
managed care industry. In order to tap into an exceedingly diverse market and adapt to different
customer groups, managed care organizations must in turn create a diverse product offering.
Currently, WellPoint offers one of the most comprehensive collections of managed healthcare
products. Some of the offerings include Preferred Provider Organization (PPO) products,
Consumber-Driven Health Plans (CDHP’s), traditional indemnity products, Health Maintenance
Organization (HMO) products, Point-of Service (POS) plans, Blue Card, Senior Plans,
Individual Plans, Medicaid and other state sponsored programs, and Medicaid. WellPoint also
offers numerous specialty and niche products such as Pharmacy, Disability, Dental, Vision, and
Behavioral Health. WellPoint’s product development and marketing enables them to target all
types of health insurance customers.
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Economic/Macro Analysis
There are several economic trends to monitor when analyzing a managed care
organization:
Demographics:
Without question, looking at demographic trends across the country is a key to examining
a company like WellPoint. The following population pyramids show the age distribution for the
years 1980, 2007, and estimated in 2025:
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In addition to getting larger, the U.S. population is also getting older. Life expectancy is
increasing due to improvements in medical technologies. Obviously, it costs money to keep
people alive longer, and typically the longer a person lives, the more likely they are to suffer
from a chronic illness. The highlighted portions show one of the largest generations, the baby
boomers, getting older. The result of these people reaching retirement age will have a material
effect on managed care companies. According to the U.S. Department of Health and Human
Services “the population age 65 and older is increasing at a rate faster than the total population.”
These people are going to need care, and WellPoint, because of their already mentioned
sustainable competitive advantages, is in a good spot to satisfy that need.
Another demographic trend to watch is the percent of people who are overweight and
obese. Obesity can lead to increased risk for a number of chronic medical problems that may
require long term care including heart disease, endometrial, breast and colon cancers, diabetes,
liver and gull bladder disease, and strokes. Being overweight can also result in high cholesterol
and triglyceride levels. Necessary treatments for these types of conditions can be very complex
and costly. Similar to the increasing percentage of elderly people, the past thirty years have seen
an increase in obesity. The following exhibit gives a good picture of the rising obesity trend in
the U.S. by state:
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Obesity Trends* Among U.S. Adults
BRFSS, 1990, 1998, 2007
(*BMI ≥30, or about 30 lbs. overweight for 5’4” person)
1998
1990
2007
No Data
<10%
10%–14%
15%–19%
20%–24%
25%–29%
≥30%
Source: CDC Behavioral Risk Factor Surveillance System.
Today about thirty percent of the U.S. adult population over twenty is considered to be obese.
This represents a startling increase of about 100% since 1980. Again WellPoint is positioned to
provide the needed health insurance to people who may require long term managed care.
Government Spending:4
It is important to examine federal budget projections for spending when looking at a
managed care company because a significant amount of government spending goes into
programs like Medicare and Medicaid. From years 2002 through the first half of 2008 the
budget has been operating at a deficit. Standard & Poor’s believes that the full year deficit will
be close to $400 billion in 2008, which represents its highest level since the record loss year of
2004. Estimates for 2009 are even less encouraging, with an anticipated deficit of $489 billion.
Clearly, Congress must be worried about this and has explored ways to cut costs. In 2005
Congress passed the Deficit Reduction Act which was set a goal of reducing Medicare spending
by $6.4 billion and $22.4 billion, and Medicaid spending by $4.8 billion and $26.1 billion, with
the first target to be reached by 2010 and the second by 2015. Spending on Medicare, however,
has not yet taken a hit due to the staggering deficit numbers; in fact it continues to rise. Just
between 2006 and 2007 it rose from $374 billion to $436 billion, an increase of 16.6 percent.
Still though, a cut in funding to either of these programs could affect WellPoint’s revenues since
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it participates in both, deriving 4% of its 2007 membership base from Medicare enrollees and 6%
from Medicaid enrollees.
Sector/Industry Analysis
As the general economy goes up and down, demand for healthcare remains largely
unaffected. This relatively stable inelastic demand is why healthcare is traditionally classified as
a defensive sector. Currently the sector has a beta of 0.7, also an indicator of its defensive
nature. Because it is a defensive sector, healthcare tends to outperform the market during times
of economic downturn. Since current conditions indicate that we are in the midst of a recession
one would expect healthcare to be performing reasonably well. Year to date the healthcare
sector is down about 25%, representing an outperformance of the S&P 500 by about 15%.
Market conditions are not likely to improve in the next six months; as a result investors should
see continued outperformance by the sector.
One would expect that since managed care is part of a defensive sector, it would be
relatively defensive as well. However, with an industry beta of 1.3, it does not appear to be as
defensive as the sector overall, and may be subject to a myriad of risk factors that other
industries in the sector do not face. Some examples of these factors include unemployment rates,
projected premium rates for Medicare and Medicaid plans, and a company’s ability to accurately
predict medical costs. Year to date the managed healthcare industry is down about 60 percent,
an underperformance of the sector by 35 percent and of the S&P 500 by 20 percent.
Trends in the industry are affected by various factors. With unemployment rising and
government spending expected to expand at a slower rate, MCO’s are increasing their focus on
offering specialized products that target people who are either uninsured or underinsured.
Healthcare cost expansion, after a moderating trend through 2005 looks to be modestly picking
up. Standard &Poor’s believes that health spending is likely to continue above GDP growth.
Managed care organizations pay close attention to these numbers. They must be able to
accurately predict what will happen in medical cost trends in order to price their products
accordingly.
As a whole, managed care is in the mature stage of the industry life cycle. Competition
is extremely fierce, and compared to other industries managed care is relatively concentrated.
The concentration is expected to continue to grow. According to Standard & Poor’s in 2007
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about 56% of the insured population was handled by the top ten insurance companies. They
expect this figure rise to 70-80% by 2015. 5 The larger companies are increasingly expanding
their reach nationally, and as a result pushing smaller competitors out. Many of these companies
are being be scooped up in mergers and acquisitions by the bigger organizations.
Company Position within Industry
As previously mentioned WellPoint is the largest managed care organization on a
membership basis. Because of this, the firm is able to take advantage of significant economies of
scale which are tremendously important in the industry. In comparison to its nearest competitors,
WellPoint has preformed inline. The following figure shows comparable returns year to date for
WellPoint, UnitedHealth, Aetna, Humana and Cigna, all members of the S&P 500 healthcare
sector:
Obviously these firms have taken quite a beating. Of the five WellPoint has preformed the best,
but only marginally so. The weakening economy seems to be the chief reason for their poor
performance, although some if it may be due to an inability to accurately predict medical cost
trends. The following table shows the company’s current (as of November 29th) market
capitalization and 2007 revenues:
Company
Market Capitalization (in
2007 Revenues (in millions)
billions)
WellPoint
18.12
61,134.30
UnitedHealth
25.38
75,431.00
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Aetna
10.06
27,599.60
Humana
5.10
25,289.99
Cigna
3.29
17,623.00
As can be seen WellPoint is one of the biggest managed care firms on a revenue and market
capitalization basis as well. Net income growth from the second half of 2007 to 2008 was rather
discouraging. WellPoint experienced a -17.3% change, but was better off than competitors Cigna
and UnitedHealth who both suffered greater than -30% changes.
As already mentioned, WellPoint is currently the BCBS licensee in 14 states. Recently,
some smaller not-for-profit Blue Cross Blue Shield plans have been considering merging and
changing their status to for-profit. It would not be surprising if WellPoint, which has
consistently expanded its reach through acquisitions, made offers on some of these plans.
WellPoint does have a very cash rich position and would be further served by adding more
regions to its already extensive BCBS coverage.
Growth Factors
The most promising growth factors that are the biggest catalysts for WellPoint are new
product offerings and further acquisitions.
New Product Offerings:
WellPoint’s product offering is expanding in order to provide more customer friendly
products. Tapping into markets of people who were previously uninsured or underinsured, or
other niche groups is one of the best ways for an MCO to increase its market penetration. Over
the past few years, this has meant getting into the public healthcare business in programs like
Medicare and Medicaid. Even though these products are usually lower margin, enrollment rates
are higher in these programs than in most managed care’s private commercial plans. WellPoint
has done a good job in bringing these businesses into their operations.
The most recent trend in reaching underinsured markets is a focus on consumerism,
which can be summed up as an effort to educate the consumer, allowing them to make more
informed decisions about their healthcare. The resulting product of this focus was the consumer
driven health plan (CDHP); a generally lower premium plan that requires more out-of-pocket
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expenses from the participant. Because the customer will be required to pay more out-of-pocket,
they become more conscious about decisions they make regarding healthcare. While it may
sound somewhat controversial, and they have received some criticism, CDHP’s have allowed
countless companies that previously could not offer healthcare to employers to do so at
affordable rates. WellPoint currently offers consumer driven health plans to all private
customers and has done well to make these products affordable to previously uninsured
customers.
Acquisitions:
In expanding its business, WellPoint has made significant acquisitions, including the
gigantic purchase of WellChoice, Inc in 2005. So far they have been able to integrate the many
acquisitions into a highly successful managed care juggernaut. As mentioned before, I believe
that WellPoint will have the opportunity to invest in further acquisitions in the coming months.
With several not-for-profit MCO’s considering merging and changing to for-profit status, most
of which already have the BCBS license, WellPoint could become an even greater force in the
industry if it were to successfully acquire some of these. Expanding the extent of their BCBS
coverage would be frightening to competitors who do not enjoy the benefits that go along with
marketing products with the industry’s strongest brand.
Risk Factors
WellPoint is subject to many risks that may have a negative impact on future
profitability. It is important to discuss some of the most pressing concerns.
Economic Concerns:
The larger general economic issues have thus far not been kind to WellPoint. As already
discussed, year to date the stock is down about 60 percent. If conditions get worse before they
get better the next six months could see even more losses. Because most customers at WellPoint
are enrolled in programs through their employers, a significant change in the employment rate
could affect WellPoint’s profitability. The employment rate has risen over the past two years
from 4.5% in the last quarter of 2006 to 6.5% in the third quarter of 2008. Weakening
employment numbers means fewer new enrollees for companies like WellPoint. In addition,
managed care organizations usually feel the effects of increasing unemployment again on a lag.
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When employees lose their jobs they usually get some severance which often includes some
health coverage. If and when these plans run out, however, the MCO takes a hit again, as
reenrollment is not going to be likely if current market conditions last.6 Also since WellPoint
does most of its business in the 14 states it has the BCBS license, if economic conditions here are
worse than the nation overall, WellPoint will be at a disadvantage compared to its competitors.7
The following table shows the unemployment rate in the aforementioned states:8
Unemployment Rate
State
State
(Oct 2008)
Unemployment Rate
(Oct 2008)
California
8.2
Missouri
6.5
Colorado
5.7
Nevada
7.6
Connecticut
6.5
New Hampshire
4.1
Georgia
7.0
New York
5.7
Indiana
6.4
Ohio
7.3
Kentucky
6.8
Virginia
4.4
Maine
5.7
Wisconsin
5.1
On and adjusted basis for population, the average unemployment in these states is approximately
6.75, which is significantly higher than the national unemployment number.
Increasing unemployment is not the only economic problem that WellPoint is facing.
Due to the recent credit crunch, market conditions have made the availability of liquid funds very
scarce. In order to pay for capital expenditures, operating costs, and debts, WellPoint needs
access to liquid assets. The firm had been relying on a $2.5 billion commercial paper program to
achieve some liquidity. However, in response to increased volatility in that market, WellPoint
decided to scale back its utilization to about $1.3 billion by the end of September. If getting
credit continues to be difficult, WellPoint could run into problems in meeting its liquidity needs
from internal sources, and long term this could result in unfavorable credit terms which might be
WellPoint’s only option.9
Competitive Forces:
Competition within the managed care industry is extremely fierce. As concentration in
the industry increases I believe that competition will increase as well. In several of the markets in
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which WellPoint does business, it must win customers from various local plans as well as bigger
national ones. Different customer groups require different products, and for the most part
WellPoint has the plan diversity required. However, as new products become available by
competitors, there is no guarantee that WellPoint will be able to adapt accordingly. In addition
to battling over customers, the firm also must fight for the services of independent agents and
brokers whom they use to market their products. Mostly, these agents are prevalent in their
individual, senior and smaller commercial business plans. These agents typically do not only sell
WellPoint products though and can be just as difficult to win over as customers. Intense
competition also exists in attracting and retaining employees.
Regulation Uncertainty:10
The federal and state governments in which WellPoint operates have enacted extensive
regulations regarding the managed care industry. Often these regulations can vary greatly from
state to state. Also, Congress at any time can reform regulations, forcing WellPoint to make
changes in its policies. Healthcare has been a hot topic this year with regard to the November
presidential election. During the race, President-elect Barack Obama set forth a plan for
universal or near- universal health coverage which would be modeled after Medicare. Under
increased regulation, private insurers would possibly be forced to accept all applicants. Clearly,
this could present a problem for a company like WellPoint. Typically people who were not
insured or were underinsured are going to take advantage of the new coverage by increasing the
rate of plan utilization. A person who would normally not receive care for a minor injury or
illness, or put that care off, because it would come out of pocket, might make a hospital visit
when home healthcare would suffice. The overall effect would be harder to predict medical
costs trends and lower margins from increased public healthcare products. However, it is
debatable whether or not we will see the promised healthcare reforms in the near future. It is
more likely that it will happen on the state level, as numerous proposals are currently either
already enacted or on the table in several of the states in which WellPoint conducts business,
including California, Colorado, Connecticut, Maine, New York, and Wisconsin. It is uncertain
what kind of effect the new regulations will have on business, but they likely will make it more
difficult to maintain margins.
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Financials
Pouring over a firm’s financial statements is an important part of valuing a company.
This section goes over the WellPoint’s income statement, balance sheet and statement of cash
flows, all three of which have been attached to the end of this report. I have also prepared a
careful discounted cash flow model.
Income Statement11:
Given that WellPoint is a managed care organization, the predominant form of revenues
received come from premiums. The remainder comes from administrative fees, and income
earned on investments that the company has made. Because premium revenue accounts for
about 93% of total revenue from operations, it is the primary driver of earnings growth. Keeping
operating expenses contained is also a key. The medical loss ratio (MLR) gauges how well
management has been able to do this.
Medical Loss Ratio
It is calculated by dividing a
83.0%
company’s total amount of medical
82.0%
costs by premium revenues. As has
81.0%
Medical Loss Ratio
80.0%
been mentioned several times, pricing
products based on projected medical
79.0%
2007 2006 2005 2004 2003
costs is crucial for maintaining
margins in this business. The figure at
the left shows the MLR for WellPoint over the last five years. In 2007, it was at its highest
point, reaching 82.4%. Average MLR across the industry is around 80% for a company that is
considered to be managing its customer base well according to Standard and Poor’s, so
WellPoint is relatively in-line.12 The foremost reason for the inflated MCR is a higher cost of
Medicare and Medicaid on a per patient basis compared to privately funded plans.
Balance Sheet:
The main thing analysts look for when examining a MCO’s balance sheet is stability of
the organization’s cash balance. Companies like WellPoint need cash to keep their bigger
commercial customers feeling safe. If a client does not believe WellPoint will be able to
maintain enough liquidity to keep their employees covered, even during times of financial crisis,
they will take their business elsewhere. WellPoint has done a solid job in keeping the cash on
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hand consistent over the past 3 years; and even during the credit crunch they have performed
admirably. The cash and cash equivalents balance as of December 31, 2007 was 2.77 billion,
and at the end of 2008’s third quarter it was still at 2.27 billion.
Statement of Cash Flows:
The main source of operating cash flow for WellPoint is through premiums. The biggest
source of investing cash flow, both inflows and outflows, is from purchasing and selling fixed
maturity securities. Taking a look at financing activities, during the financial years 2006 and
2007 and earlier this year WellPoint repurchased and retired significant portions of stock. The
end result has been a trend for lots of outflows from financing activities.
DCF Analysis:
In order to come up with a target value for the price of WellPoint, I have constructed a
discounted cash flow analysis which is attached at the end of this report. In building this model
most of the information gathered was derived from the companies various financial statements.
Assuming a 13% terminal discount rate and a 1% terminal free cash flow growth, I arrived at a
target price of $49.73, which represents an upside of 39.87 percent. A sensitivity analysis was
also preformed, varying the discount rate from 10-13 percent and the terminal FCF growth rate
from 1-3 percent. The decision to go with 1% FCF growth was based on the fact that it looks
like growth is slowing for WellPoint, and I expect it to grow slower than GDP in the future. A
13% discount rate was chosen to be best on the basis that it is slightly less than the expected
industry growth rate of 13.37 percent. Assumptions used in the DCF are listed below:
Segment Analysis:
• Net Sales Growth- Commercial and Consumer- growth expected to slow unless
WellPoint completes aforementioned acquisitions
• Net Sales Growth- Specialty Senior and State Sponsored- biggest growth will come from
this segment
• Net Sales Growth-Other- small constant growth
• Operating Margins- Assumed constant for next three years, although overall margins
might shrink slightly because of increased public health insurance
Income Statement, Balance Sheet Analysis, and Cash Flow Analysis:
• Interest Expense- expected to remain constant as a percent of sales
• Amortization of Other Intangible Assets- expected to remain constant as a percent of
sales
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•
•
•
•
•
•
•
P a g e | 17
Income Tax- assumed to continue at 36.4%
Cash and Equivalents- assumed to stay at $2,767.9 million
Accounts Receivable- increase at short term average of 4.70% per year
Inventory- none
Accounts Payable- increase at short term average of 5.68% per year
Capital Expenditures- assumed to remain at a constant 0.48% of sales
Depreciation and Amortization- assumed to remain at a constant 0.93% of sales
Valuation Analysis
Valuations were made on an absolute basis, relative to the S&P 500, and relative to the
healthcare sector.
Absolute Valuation:
The absolute valuation, while not necessarily the best way to estimate a target price, does
give some gauge against which to measure the DCF. Listed below is the analysis:
Absolute
Valuation
P/Forward
E
P/S
High
Low
Mean
Target
Multiple
6.1
8
Current
Target
X/Share
6.42
18.2
5.2
13.9
1.14
0.26
0.73
0.31
0.45
120.1
3.6
0.7
2
0.8
1.3
44.5
P/EBITDA
1.12
3.2
8.5
3.8
5.5
9.36
P/CF
17.6
4.7
14.2
5.6
8.5
6.35
Target
Price
51.36
54.05
P/B
57.85
51.53
54.04
P/E/G
Ratio
ROE
1.2
0.4
0.9
0.5
0.7
71.2
49.84
17.60%
10.20%
13.00%
14.00%
13.00%
254.28
33.06
Average
50.24
Currently these measures were very near their all time lows for WellPoint. The major assumption
used in this valuation was that the values would at least get somewhat closer to their historical
averages. In order to compare this method with the already discussed DCF analysis, a mean
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value was calculated resulting in a target price is $50.49, which represents an upside of 41.38
percent. This value is relatively in line with the target price determined in the DCF model,
further increasing the validity of both methods.
Relative to S&P 500:
WELLPOINT INCORPORATED NEW (WLP) Price 35.60
2001
2002
2003
2004
2005
2006
2007
StockVal ®
2008
2009
1.2
HI
LO
ME
CU
1.0
0.8
1.17
0.45
0.75
0.55
0.6
11-23-2001
11-28-2008
0.4
PRICE / YEAR-FORWARD EARNINGS RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
0.8
HI
LO
ME
CU
0.6
0.76
0.26
0.47
0.38
0.4
11-23-2001
11-28-2008
0.2
PRICE / SALES RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.2
HI
LO
ME
CU
0.9
1.14
0.39
0.66
0.48
0.6
11-23-2001
11-28-2008
0.3
PRICE / BOOK VALUE RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.4
HI
LO
ME
CU
1.2
1.0
1.38 •
0.62
1.15
0.79
0.8
01-06-2006
11-28-2008
0.6
PRICE / EBITDA RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
Most of these multiples are below their historical mean, which indicates that the stock
may be relatively undervalued. If these values do revert to the mean, or even get somewhat
closer to it, the stock’s price will likely go up.
Student Investment Management: WellPoint, Inc.
P a g e | 19
Relative to Healthcare Sector:
WELLPOINT INCORPORATED NEW (WLP) Price 35.60
2001
2002
2003
2004
2005
2006
2007
StockVal ®
2008
2009
1.2
HI
LO
ME
CU
1.0
0.8
1.03
0.42
0.71
0.60
0.6
0.4
PRICE / YEAR-FORWARD EARNINGS RELATIVE TO S&P HEALTH CARE SECTOR COMP ADJ (SP-35) M-Wtd
0.6
11-23-2001
11-28-2008
HI
LO
ME
CU
0.4
0.58
0.14
0.33
0.28
0.2
11-23-2001
11-28-2008
0.0
PRICE / SALES RELATIVE TO S&P HEALTH CARE SECTOR COMP ADJ (SP-35) M-Wtd
0.6
HI
LO
ME
CU
0.5
0.4
0.60
0.25
0.46
0.36
0.3
11-23-2001
11-28-2008
0.2
PRICE / BOOK VALUE RELATIVE TO S&P HEALTH CARE SECTOR COMP ADJ (SP-35) M-Wtd
0.9
HI
LO
ME
CU
0.7
0.5
0.90 •
0.38
0.67
0.47
0.4
01-06-2006
11-28-2008
0.3
PRICE / EBITDA RELATIVE TO S&P HEALTH CARE SECTOR COMP ADJ (SP-35) M-Wtd
These measures also show that WellPoint may be trading at a discount compared to the
healthcare sector as a whole. All current values are below historical averages.
Recommendation
Based on the analysis presented here, and on the various valuation techniques used, I
would recommend buying WellPoint. The DCF analysis provided a target price of $49.75, a
potential upside of 39.74%, while the multiples analysis determined an average target of $50.24,
or 41.12% upside potential. Further, if these two measures are averaged, the resulting target
price is $49.99, or 40.43% upside. With that having been said, this upside puts the stock above
the threshold for a buy. At its current price WellPoint is undervalued, and it has some room to
grow. A summary of the pros and cons of the recommendation follow:
Student Investment Management: WellPoint, Inc.
Pros
•
•
•
•
WellPoint is the market leader on a
membership basis and is the licensee for
the highly reputable BCBS brand in its
most important states
Demographic trends are showing an
increase in obesity and an aging
population- the result more people who
will need extensive healthcare coverage
Very good opportunity for expansion from
an acquisitions standpoint
Both DCF and multiples valuation showed
significant potential upside
P a g e | 20
Cons
•
•
•
Competition in the managed care industry
is extremely fierce
Recessionary times have not proved well
for WellPoint stock as it has lost 59% ytd.
If slumping economy continues, very real
threat of WellPoint underperforming
Pricing trends may become increasingly
harder to predict, putting strain on
WellPoint to maintain its margins- increase
in chronic illnesses (from higher levels of
obesity and older pop.) require more
complex and costly treatments
WellPoint really fell off after a miscalculation of medical trends in the first quarter of 2008,
resulting in an abnormally high medical loss ratio. The stock quickly plunged from a price of $72
to $44 in less than a month; the biggest drop was between March 10 and 11 when it went from
$67 to $48. Largely this type of miscalculation was industry wide, and problems were further
compounded when the world economy moved into a recessionary period; the stock got beaten
down to levels that have not been seen since the Anthem-WellPoint merger in 2005. However,
it seems likely that WellPoint has been oversold. The stock may take some time to recover, but
both the DCF and multiples showed a 12-month target price around $50, leading to the final
recommendation of a BUY.
Student Investment Management: WellPoint, Inc.
P a g e | 21
DCF Spreadsheet
DCF Valuation
10/20/2008
Ticker: WLP
Bobby Lazarony
Terminal Discount Rate=
Terminal FCF Growth=
13.0%
1.0%
Forecast
Year
2008E
2009E
Terminal
2010E
2011E
2012E
2013E
2014E
2015E
2016E
2017E
2018E
64,528
4.57%
67,538
4.66%
70,239
4.00%
72,698
3.50%
74,879
3.00%
76,750
2.50%
78,285
2.00%
79,460
1.50%
80,254
1.00%
1.00%
61,705
Operating Income
Operating Margin
5,215
8.45%
5,302
8.22%
5,429
8.04%
5,549
7.90%
5,743
7.90%
5,915
7.90%
5,987
7.80%
6,106
7.80%
6,118
7.70%
6,180
7.70%
7.60%
Interest - net
Interest % of Sales
457
0.74%
478
0.74%
500
0.74%
500
0.71%
500
0.69%
500
0.67%
500
0.65%
500
0.64%
500
0.63%
500
0.62%
0.62%
6,160
500
Amortization of
other intangible
assets
As a % of sales
309
323
338
351
363
374
384
391
397
401
405
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
0.50%
Taxes
Tax Rate
1,620
36.4%
1,639
36.4%
1,671
36.4%
1,710
36.4%
1,776
36.4%
1,835
36.4%
1,857
36.4%
1,898
36.4%
1,901
36.4%
1,921
36.4%
36.4%
-
-
-
-
-
-
-
-
-
-
2,830
2,863
1.16%
2,920
2.00%
2,988
2.32%
3,104
3.87%
3,206
3.31%
3,246
1.23%
3,317
2.20%
3,321
0.12%
3,357
1.10%
Minority Interest
Net Income
% Growth
Add
Depreciation/Amort
% of Sales
Plus/(minus)
Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
Free Cash Flow
YOY growth
1,913
3,342
-0.44%
574
600
628
653
676
696
714
728
739
746
754
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
0.93%
(307)
(313)
(318)
(321)
0.40%
368
0.48%
0.40%
376
0.48%
0.40%
381
0.48%
0.40%
385
0.48%
(623)
(296)
(312)
(281)
(291)
(300)
-1.01%
-0.46%
-0.46%
-0.40%
-0.40%
-0.40%
296
0.48%
310
0.48%
324
0.48%
337
0.48%
349
0.48%
359
0.48%
2,485
(324)
-0.40%
389
0.48%
2,858
2,911
3,023
3,140
3,244
3,284
3,356
3,360
3,397
3,383
14.98%
1.89%
3.83%
3.87%
3.30%
1.24%
2.19%
0.14%
1.09%
-0.42%
Terminal
Terminal Value
NPV of free cash
flows
NPV of terminal
value
Projected Equity
Value
Free Cash Flow
Yield
Shares Outstanding
28,473
16,986
67%
EV/EBITDA
8,388
33%
Free Cash
Yield
25,373
509.0
Current Price
$ 35.60
Implied equity
value/share
$ 49.75
Upside/(Downside)
to DCF
Cash
Debt
P/E
9.79%
39.74%
2,768
9,024
Value
81,057
Revenue
% Growth
28,472.5
8.5
5.02
11.88%
Student Investment Management: WellPoint, Inc.
Sensitivity Analysis (Implied Equity Value/share)
Terminal
FCF
Growth
Terminal Discount Rate
10.00%
10.50%
11.00%
11.50%
12.00%
12.50%
13.00%
66.61
63.06
59.87
56.97
54.35
51.95
49.75
68.45
66.64
61.23
55.38
52.86
50.55
70.53
66.41
62.75
59.48
56.53
53.85
51.42
72.88
68.40
64.45
60.93
57.79
54.95
52.38
75.56
70.66
66.36
62.57
59.19
56.16
53.44
Terminal
FCF
Growth
1.00%
10.00%
87.11%
10.50%
77.13%
11.00%
68.17%
11.50%
60.03%
12.00%
52.67%
12.50%
45.93%
13.00%
39.75%
1.50%
92.28%
87.19%
71.99%
63.37%
55.56%
48.48%
41.99%
2.00%
98.12%
86.54%
76.26%
67.08%
58.79%
51.26%
44.44%
2.50%
104.72%
92.13%
81.04%
71.15%
62.33%
54.35%
47.13%
3.00%
112.25%
98.48%
86.40%
75.76%
66.26%
57.75%
50.11%
1.00%
1.50%
2.00%
2.50%
3.00%
58.16
Terminal Discount Rate
Consolidated Financial Statements for WellPoint, Inc.
Balance Sheet:
P a g e | 22
Student Investment Management: WellPoint, Inc.
P a g e | 23
(In millions, except share data)
Assets
Current assets:
Cash and cash equivalents
Investments available-for-sale, at fair value:
Fixed maturity securities (amortized cost of $1,814.5 and $481.5)
Equity securities (cost of $1,732.7 and $1,669.7)
Other invested assets, current
Accrued investment income
Premium and self-funded receivables
Other receivables
Income tax receivable
Securities lending collateral
Deferred tax assets, net
Other current assets
Total current assets
Long-term investments available-for-sale, at fair value:
Fixed maturity securities (amortized cost of $13,832.6 and $15,004.6)
Equity securities (cost of $43.4 and $82.7)
Other invested assets, long-term
Property and equipment, net
Goodwill
Other intangible assets
Other noncurrent assets
Total assets
Liabilities and shareholders’ equity
Liabilities
Current liabilities:
Policy liabilities:
Medical claims payable
Reserves for future policy benefits
Other policyholder liabilities
Total policy liabilities
Unearned income
Accounts payable and accrued expenses
Income taxes payable
Security trades pending payable
Securities lending payable
Current portion of long-term debt
Other current liabilities
Total current liabilities
Long-term debt, less current portion
Reserves for future policy benefits, noncurrent
Deferred tax liability, net
Other noncurrent liabilities
Total liabilities
Commitments and contingencies—Note 18
Shareholders’ equity
Preferred stock, without par value, shares authorized—100,000,000; shares issued and outstanding—none
Common stock, par value $0.01, shares authorized—900,000,000;shares issued and outstanding: 556,212,039 and 615,500,865
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
Total liabilities and shareholders’ equity
December 31
2007
2006
$
$
$
$
2,767.9
$
2,602.1
1,832.6
1,893.7
40.3
165.8
2,870.1
996.4
0.9
854.1
559.6
1,050.4
13,031.8
465.4
1,984.5
72.8
157.2
2,335.3
1,172.7
—
904.7
642.6
1,284.5
11,621.8
13,917.3
45.1
752.9
995.9
13,435.4
9,220.8
660.8
52,060.0
14,972.4
86.2
628.8
988.6
13,383.5
9,396.2
497.4
51,574.9
5,788.0
63.7
1,832.2
7,683.9
1,114.6
2,909.6
—
50.6
854.1
20.4
1,755.0
14,388.2
9,023.5
661.9
3,004.4
1,991.6
29,069.6
—
5.6
18,441.1
4,387.6
156.1
22,990.4
52,060.0
$
$
$
5,290.3
76.3
2,055.7
7,422.3
987.9
3,242.2
538.2
124.8
904.7
521.0
1,397.4
15,138.5
6,493.2
646.9
3,350.2
1,370.3
26,999.1
—
6.1
19,863.5
4,656.1
50.1
24,575.8
51,574.9
Student Investment Management: WellPoint, Inc.
P a g e | 24
Income Statement:
(In millions, except per share data)
Revenues
Premiums
Administrative fees
Other revenue
Total operating revenue
Net investment income
Net realized gains (losses) on investments
Total revenues
Expenses
Benefit expense
Selling, general and administrative expense:
Selling expense
General and administrative expense
Total selling, general and administrative expense
Cost of drugs
Interest expense
Amortization of other intangible assets
Total expenses
Income before income tax expense
Income tax expense
Net income
Net income per share
Basic
Diluted
2007
Years ended December 31
2006
2005
$ 55,865.0
3,674.6
582.4
60,122.0
1,001.1
11.2
61,134.3
$ 51,971.9
3,595.4
593.1
56,160.4
878.7
(0.3)
57,038.8
$ 40,680.0
2,792.0
519.2
43,991.2
633.1
(10.2)
44,614.1
46,036.1
42,191.4
32,598.8
1,716.8
6,984.7
8,701.5
400.2
447.9
290.7
55,876.4
5,257.9
1,912.5
$ 3,345.4
1,654.5
7,163.2
8,817.7
414.4
403.5
297.4
52,124.4
4,914.4
1,819.5
$ 3,094.9
1,474.2
5,798.5
7,272.7
387.2
226.2
238.9
40,723.8
3,890.3
1,426.5
$ 2,463.8
$
$
$
$
$
$
5.64
5.56
4.93
4.82
4.03
3.94
Student Investment Management: WellPoint, Inc.
P a g e | 25
Endnotes:
1
WellPoint, Inc. 2007 Form 10-K
2
10-K Form
3
10-K Form
4
Seligman, Phillip M .Standard &Poor’s Industry Surveys: Healthcare: Managed Care. October 16, 2008.
5
Seligman, Phillip M .Standard &Poor’s Industry Surveys: Healthcare: Managed Care. October 16, 2008.
6
Seligman, Phillip M .Standard &Poor’s Industry Surveys: Healthcare: Managed Care. October 16, 2008.
7
10-K
8
Bureau of Labor Statistics: www.bls.gov
9
WellPoint, Inc. Quarterly Report for Third Quarter 2008.
10
Seligman, Phillip M .Standard &Poor’s Industry Surveys: Healthcare: Managed Care. October 16,
2008.
11
10-K
12
Seligman, Phillip M .Standard &Poor’s Industry Surveys: Healthcare: Managed Care. October 16,
2008.