Aetna Announces Its Acquisition of Humana
Market response
The Aetna-Humana deal was announced on July 3, 2015. On July 6, the next trading day, Aetna’s (AET) shares dropped to $117.43—an almost 9.3% drop from the closing price on the announcement day. This reaction reflects market sentiment that Aetna is paying a higher-than-fair price to acquire Humana (HUM).
The above graph shows the share price movements of Aetna and Humana post–March 2015. The first rumors of the Aetna-Humana deal surfaced in May 2015. Following these rumours, despite failing to meet analyst expectations in 1Q15 results, Humana’s stock displayed an upward trend. Aetna, on the other hand, managed to post healthy earnings. Yet the stock continued to show muted growth.
Humana’s premium
The Aetna-Humana deal should close in the second half of 2016, following approval from anti-trust regulators. The deal settled at $37 billion or $230.11 per Humana share in cash and stock, comprising $125 in cash and $105.11 in Aetna’s shares per Humana share. Based on closing Aetna’s share price on July 2, 2015, the deal involves an exchange ratio of 0.8375 Aetna shares per Humana share. This valuation is at a premium of 29% of Humana’s unaffected share price as of May 28, 2015. After July 2, rumors of Humana’s probable acquisition made rounds in the market, affecting the company’s share values.
Humana’s performance
In 1Q15, Humana added more than a million new members, mostly government-sponsored Medicare and Medicaid enrolees. In the past year, the company also witnessed a steep rise in total revenues of about 18%. However, Humana’s net profits have been consistently lower than analyst expectations. This performance is due mainly to Humana’s higher operating expenses, involving medical services to aged people. Older people generally suffer from several chronic ailments and fall prey more easily to infectious diseases, adding to Humana’s medical-related expenses.
Following the deal announcement, Humana further cut its profit outlook, citing higher-than-expected use of hospital services by the company’s medicare advantage (or MA) customers. The company has reduced its expected 2015 operating profit estimate by more than 8%. Reduced profits could mean that the deal might underperform Aetna’s revenue and EBITDA estimates for 2015, amounting to $115 billion and $8 billion, respectively. Plus, the large premium requires Aetna to achieve substantial cost efficiencies to make the deal profitable. In this kind of scenario, there remains the possibility that the expensive deal could be rejected by Aetna’s shareholders, as it would mean issuance and subsequent dilution of Aetna’s stock.