Did Wellpoint overpay for Caremore? No….not yet anyway

Summary

• Wellpoint probably paid full value for Caremore (if that company’s performance is as powerful as limited data suggests) but did not overpay.
• In addition, Caremore offers several powerful upsides if Wellpoint can continue to grow the model.
• However, Wellpoint will need to tread carefully to avoid damaging its purchase, given an uncertain record with vertical models (NextRx) and the inherent challenges in integrating fast-growing, PE-fueled innovators into large, mature businesses.
• Some indicator of Wellpoint’s strategy for Caremore will be given by its approach to Arizona — a key market for Caremore but where HCSC – not Wellpoint – has the Blues license.

A few weeks ago, Wellpoint acquired Caremore for an estimated $800M. Caremore is a vertically integrated provider / Medicare Advantage (MA) plan with ~54K MA lives and 26 care centers with broad medical portfolios. There is certainly an interesting business model here: Dartmouth Atlas provides plenty of evidence that a narrow primary care network with strong incentives to control downstream costs can have attractive economics. Further, Caremore’s management team (old hands from Pacificare) and current ownwers (JP Morgan, Crystal Cove Partners) certainly knew how to prove out a business model. Just look at how impressively Caremore succeeded in two critical pre-sale milestones:

• Consistently strong organic growth – 39% CAGR since 2008 in special needs plans (SNP) and 26% CAGR in the regular non-SNP MA
• Success at launching the vertically integrated model in green fields (Arizona and Nevada)

Even so, at this point, Caremore only has 54K lives and 26 care centers. Last year, Healthspring bought Bravo with 100K MA lives and 290K Medicare Part D lives for about $250M less than what Wellpoint paid for Caremore. Also last year, Humana bought Concentra’s 300 medical centers for $790M (so $10M less than the Caremore deal).

So, did Wellpoint overpay? My take is no (assuming Wellpoint’s due diligence confirmed Caremore’s capabilities as an efffective narrow network medical home); but the stand-alone value of Caremore seems fully priced and Wellpoint will need to work to make sure it collects an upside.

First, here’s why $800M seems like a reasonble number:

• ~$400M of value can be reasonably attributed to the MA business (at today’s equivalent to the Healthspring Bravo pricing, factoring out the value of Medicare Part D lives and factoring in the improved valuations on the MA business overall since 2010)
• ~$200M can be attributed to the profits from care delivery (given the typical demand of Medicare eligibles for the Medicare Part B services available in Caremore’s centers, the high share of these services Caremore is able to secure given its narrow network strategy, and the profitability and valuation of comparable companies).
• The residual $200M can reasonably be attributed to savings in reduced hospital costs due to the tight primary care management Caremore physicians presumably practice. Savings 5-8% of the Medicare Part A costs on Caremore’s MA lives (e.g. by eliminating avoidable readmissions or treating more conditions before they reach the hospital setting) would be sufficient.

(email me if you want to engage on the detailed assumptions)

If Caremore as a stand-alone was fully valued in the acquisition, how does Wellpoint capture an upside? A few thoughts (in rough declining order of value):

• Differentiated offer to turbo-charge MA growth: Wellpoint’s MA lives have been growing at ~5-6% per year in the most recent quarter, roughly the same as United’s but significantly weaker than Humana’s 10% year-over-year growth. Given the mounting evidence that consumers are willing to accept narrow networks in return for good care and a good price, Wellpoint could do well to have a vertically integrated offering. Further, the Caremore product may remain free of any narrow network impediments in Wellpoint’s legacy provider contracts.
• Provider insight: Knowing how a narrow network patient centered medical home operates “from the inside” can help Wellpoint design their programs (tools, incentives, structures) to rapidly guide core providers to be more effective.
• Counter leverage: An ability to launch Caremore care centers in greenfield settings offers useful leverage vs consolidating provider systems. A credible entry threat can persuade highly consolidated providers to be more reasonable in their rate positions (in a way that will tend to benefit just Wellpoint).
• SNP beachhead: Caremore has a strong position in SNPs specialized in chronic conditions (so called C-SNPs), an arena which has largely been the playground of United and XL Health. Although C-SNPs only have about 200K MA so far, Wellpoint might figure out ways to expand eligbility for these programs (e.g., encouraging potential customers for traditional MA plans to consider C-SNPs) and offer capabilities to other Blues plans looking to make a dent in United’s Evercare or XL Health’s Care improvement Plus businesses.

Of course, critical to extracting these upsides is Wellpoint’s ability to roll-out the Caremore model in more markets (not just capture legacy momentum). How will Wellpoint maintain the interest of executives now that the liquidity event has passed and they are counting the days on their earn outs? How will Wellpoint attract physicians who may have liked working for a small, upstart provider model but now find themselves working for a much larger, much more payer-centric company? Wellpoint will need to manage the integration carefully and is probably wise to wait until the end of the year to close and until 2013 before promising earning accrtion. Otherwise, Caremore might not even maintain momentum growth (and, as a result, Wellpoint might end up having overpaid).

One final thought: Wellpoint’s approach to Caremore’s legacy Arizona business will be a useful strategic signal. The Blues license in Arizona is held by HCSC (Wellpoint holds the license in Caremore’s other markets) and, by Association rules, Wellpoint cannot sell Blue branded products there. Two options:

1. Wellpoint could choose to leave Caremore under its own brand and continue to operate in Arizona — but that would prevent Wellpoint from leveraging the Blue brand to accelerate Caremore’s growth.
2. Wellpoint could transition Caremore to the Blue brand, play nice wth HCSC and, perhaps, cede the lives. This would also open the door to collaborations with other Blues around SNPs or strong primary care models in other markets (similar to the Intel Inside kind of deal on Medicaid Wellpoint struck with BCBS South Carolina several years ago).

My guess is option 2. There is a precedent in the deal Wellpoint agreed with HCSC for its non-Blue Unicare business in Texas and Illinois in 2009. Either way, Wellpoint’s choice will be an interesting signal for how it wants to work with the non-profit Blues through the turmoil and industry line-redrawing resulting from reform.