Consumerism bulk-up: Quick thoughts on Aetna’s acquisition of PayFlex

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Payflex is an administrator of account-based benefits including HSAs, HRAs, FSAs and COBRA benefits. The company has $58M in revenues, 1M individual consumer accounts and 3,300 employer customers. On Monday, Aetna accounced plans to acquire the company for $202M.

The acquisition pricing looks rich relative to the other benchmark out there: Wageworks is a competitor about 2x the size of Payflex and which recently filed an IPO to sell 23% of the company for $75M (in the works at least since April and described in detail in the registration statement submitted on Tuesday). Wageworks’ 2010 revenues were $115M, implying a P/S ratio of 2.8. Aetna is paying an implied P/S ratio of 3.5 which is quite a premium. (Of course, profits would be a better basis of comparing pricing than revenues, but Payflex profits have not been disclosed and Wageworks’ has been muddied by some convertable debt).

Payflex went up for auction this past February and that the strategic investors were willing to pay a lot more than the financial investors. Why?

In a word: synergies. While the market for account-based products continues to blossom, the pure play business model (such as Payflex or Wageworks) appears to be losing traction vs. the large health insurers like Aetna or United or the financial services players such as Mellon. Wageworks, for example, saw its healthcare revenues grow 7% in 2010, while overall HSA lives grew 14% and United saw its CDHP lives grow 38% (granted these are all not strictly comparable: Wageworks will have HRA revenues included and CDHP are not necessarily account-based, but there is enough overlap across categories and the differences are stark enough to be indicative). Failing to grow organically explains why Wageworks has shifted to an acquisition-based growth strategy (and presumably why they are looking for cheaper sources of capital through an IPO).

The synergy story has several pieces: Account-based benefits is a scale-driven business. Aetna has 1M lives in it today; adding Payflex doubles this number. Assuming a scale curve of 80% or so (not unreasonable in a technology-heavy service model), per account service costs should decline by 20%. Further, Payflex offers a layer of health and wellness services (currently partnered through LiveHealthier). Aetna can presumably replace the vendor and save their profit margin, and perhaps expand capabilities. Finally, there may be top line synergies through cross-selling: There are certainly groups where Aetna has the medical and where, for example, Wageworks could be displaced with Payflex; or groups where Payflex has the HSA and Aetna might leverage this beachhead to push into the rest of the medical.

More broadly, Aetna needs to scale up vs. United. Account-based products are attractive for cost-conscious buyers and healthcare reform will create plenty more of those (especially if McKinsey’s predicted employer opt-out comes to fruition). There is ample evidence consumers buying individual plans will opt for account based products like HSAs. Aetna will want to be comeptitive here, and will, accordingly, need to bulk up. United has 4M lives in CDHP while Aetna quotes 2M. Being half the size can be fatal in a scale driven business.

In addition, Payflex has some interesting experiences with small employers: for example, with Meltzer Group, a brokerage firm with 1,800 employer groups, some as small as 3 people. They also won an interesting contract with the Massachusetts Connector this past March to provide wellness services to small groups buying on the exchange — potentially a very attractive precedent and experience given the looming proliferation of comparable exchanges under reform.

Finally, the acquisition provides more evidence of Aetna’s strategic commitment to the benefits side of health insurance vs. dabbling in care provision like Humana (Concentra) and Wellpoint (Caremore).