Credit analyst says consider Anthem only with event risk priced in

By Ronda Fears

Nashville, Tenn., June 25 - As Anthem Inc. moves ahead with its $4 billion acquisition of Trigon Healthcare, Kathy Shanley, senior bond analyst with Gimme Credit, says the credit should reflect ongoing event risk.

"We view Anthem as well managed, and the ongoing consolidation of the industry enhances the diversity of its operations," Shanley said in a report Tuesday.

"We'd consider buying the new bond deal, but only if the spread reflects the ongoing acquisition-related event risk."

Anthem (Baa1/BBB) is planning to issue public debt to term out the financing of its proposed acquisition of Virginia-based Trigon.

The cash and stock deal is valued at about $4 billion, with the cash cost at about $1.2 billion, and is expected to close in the second quarter, pending regulatory approval.

Anthem has already secured bridge financing in the event that it does not complete a public debt offering before the merger closing, but locking in long-term funding for the deal would take the issue of refinancing risk off the table, Shanley said.

Anthem already serves eight million members in Indiana, Kentucky, Ohio, Connecticut, New Hampshire, Maine, Colorado and Nevada, with the leading market share in seven of the eight states.

With Trigon it will add Virginia's largest health care company to its roster.

Antitrust approval for the deal has been received.

Anthem filed a merger application with the state of Virginia at the end of May, with a public hearing set for July.

Since Trigon demutualized in 1997 and has been publicly traded for several years, Shanley said she does not expect the approval process to be as complicated as the proposed Wellpoint-Carefirst transaction under way in Maryland.

Anthem plans to fund the cash component of the purchase with $950 million in debt financing, combined with about $250 million in cash on hand.

With about $300 million in short-term debt assumed from Trigon included, pro forma debt to capital is about 29%, although Shanley said she expects cash flow will be adequate to allow this ratio to trend down toward the mid-20% range absent further acquisitions.

The deal will add over $3 billion in goodwill and other intangible assets to the balance sheet.

Synergies are projected at $40 million next year, with the estimated benefit rising to $75 million by 2004.

"Although Anthem's pro forma leverage, assuming completion of the Trigon merger and the proposed debt financing, remains moderate, its acquisitive appetite should be considered in the pricing of the new bond deal," Shanley said.

"Opportunities for consolidation in the health care sector are rapidly diminishing."

At the end of last year, there were only 43 Blue Cross/Blue Shield companies out of more than 125 separate firms prior to the mid-1980s.

"Some of the remaining large Blue Cross companies are determined to hold onto their not-for-profit status," Shanley said.

"Additionally, as Anthem and its rival Wellpoint become bigger and more visible in the health care industry, they will be under pressure to pay higher prices for incremental acquisitions."

They will also be bigger targets for the never-ending stream of plaintiffs unhappy about various aspects of the U.S. healthcare system, she noted.

This phenomenon is on display in Kansas, where Anthem is trying to buy Blue Cross and Blue Shield of Kansas.

Earlier this month a court in Kansas overturned the decision of the Kansas Department of Insurance, which is trying to block the deal. The case is being appealed.

Under the proposed terms, Anthem would pay $190 million in cash plus $131 million in existing reserves to demutualize and acquire the Kansas company.

"Although the court ruling favors Anthem, the Trigon deal raises questions about whether the price is high enough even correcting for differences in profitability," Shanley said.

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