In a market of low cost debt, major deals that include a large portion paid in cash easily become accretive. The latest deal reportedly in the works is the purchase of Cigna by Anthem. The deal follows news that Humana is up for sale.
The huge profits of Anthem makes the purchase of the smaller health benefits provider very accretive over the long term. The amazing part of the equation is that Anthem and the other health benefits providers have already seen huge gains in the last couple of years. In Time To Head For The Exits At Anthem?, the suggestion was that investors start looking for an exit point with the company reducing stock buybacks after years of stock gains. The news of a major purchase could allow for one last jump in the stock to collect before exiting the position.
The WSJ suggests the offering price for Cigna was $175. The deal would value the company worth upwards of $45 billion, or comparative to the value of Anthem. The deal works out very accretive for Anthem shareholders if a major portion of the transaction is paid in cash. The principal reason is that current cash on the balance sheet isn’t earning income for the company, nor does it cost a lot to pay debt at the current low interest rate environment.
A deal for Cigna estimated at 40/60 cash to equity by analyst Chris Rigg at Susquehanna is very accretive to Anthem shareholders. Rigg forecasts a roughly 10% accretion to earnings using a synergy of $1 billion. The numbers actually suggest a higher amount of benefit to 2016 earnings even using a $185 deal price.
Quick calculation:
- Anthem 2016e: $11.10 eps x 264.5M shares = $2,936M
- Cigna 2016e: $9.49 eps x 257.4M shares = $2,443M
- Total 2016e: $5,379M + $1,000 synergy = $6,379M
- Total shares: 264.5M + 173.2M = 438M shares outstanding*
- Net income: $6,379M – $950M interest = $5,429M
- EPS forecast: $4,429/438M shares = $12.39
*Using a $185 price for Cigna a current $165 price for Anthem and a deal for 60% equity, the shares delivered to Cigna shareholders will equal roughly 173.2 million shares.
The big question with the deal is how Anthem chooses to finance the cash payments of roughly $19 billion. Even if the company borrowed all $19 billion at a 5% interest rate, the new entity would only pay roughly $950 million in annual interest payments. Naturally, the company would quickly reduce that debt level so those interest payments are only a short-term impact.
Based on the above numbers, the new Anthem earns $12.39 per share prior to paying down debt that would quickly add another $2 per share to earnings.
One of the prime reasons that Cigna is the target and not Humana is the huge premium that one would have to pay for the later. Humana was already more expensive before the recent spike in the stock.
Analyst Chris Rigg sees Humana even having to cut numbers by 2016 so the stock is less attractive on that basis as well.
The quick takeaway is that Anthem could easily offer $185 per share for Cigna and still achieve substantially accretive earnings for shareholders. The stock even has several upside catalysts to the EPS projections including lower debt costs and larger synergies than the $1 billion estimate.
At the current 2016 PE ratio of nearly 15, Anthem would trade up to $186 with plenty of more upside. With a deal in the works, the time to exit the position is after another jump in the stock.
Date: June 16, 2015