Bear Stearns bullish on Anthem convertibles to play compelling new stock story

By Ronda Fears

Nashville, Tenn., Nov. 15 - Bear Stearns & Co. analysts are bullish on the new Anthem Inc. stock. And, the insurance company's new 6% mandatory convertible is a great way to play the name, Bear Stearns convertible analysts said.

The 6% converts were sold at par of 50 just a couple of weeks ago and have climbed to over 60 as the stock rose from the IPO price of $36 to $45 in Thursday's session.

Just on Oct. 29, Anthem completed its demutualization process with its $1.7 billion initial public offering, which was accompanied by the $200 million three-year mandatory convertible. The convert sold with a 6% dividend rate and 22% initial conversion premium.

"We like these convertibles," said Sarah Gallagher, convertible analyst at Bear Stearns. Not only because of the underlying stock," she added, but "there's great yield pick up."

Anthem on Wednesday reported third-quarter earnings per share of 76c before one-time items, up 33% from a year ago and in line with the Bear Stearns outlook. Anthem posted third quarter net income of $111.5 million, or $1.08 per share, versus $63.5 million, or 62c per share, in third quarter 2000 on a 12% gain in operating revenues to $2.5 billion. For the nine months ending Sept. 30, the company posted net income of $254.5 million, or $2.47 per share, compared with $153.8 million, or $1.49 per share, in the first nine months of 2000 on a 21% rise in operating revenues to $7.5 billion.

Results in the third quarter of this year also exclude $72.1 million in pre-tax net realized capital gains and Anthem's demutualization pre-tax expenses of about $13.6 million, a Bear Stearns report Thursday noted. The realized capital gains reflect $65.2 million of gains accrued as a result of shifting investments away from equities and into fixed income. Equities represented about 4% of Anthem's investment portfolio at Sept. 30, down from 11% at the end of second quarter.

Operating earnings increased 48% from a year ago, to $79.1 million, in line with Bear Stearns' outlook as well as the company's revenue growth. Total membership increased 10% year over year, to 7.83 million members, led by 19% growth in the national accounts business. Total self-funded membership increased 18% year over year, to 4.05 million members, while full-risk membership rose 2.0% from a year ago. The Bear Stearns report noted that full-risk commercial premium yields were up 14% to 15% in the quarter, while commercial medical cost trends were in the 12% to 13% range. The report also noted better-than-anticipated cost controls at Anthem, as well as strengthened administrative leverage on increased revenues.

Bear Stearns healthcare services and managed care equity analyst John Rex has a buy rating on the stock and upped the 2002 and 2003 EPS outlook by 20c per share each year, lifting the stock price target to $54. Bear Stearns raised its estimate for full year 2002 net EPS to $3.65 from $3.45 and the full year 2003 net EPS estimate to $4.15 from $3.95. For 2002, the company anticipates net EPS of $3.55 to $3.65 per share.

"Most of the improvement in our earnings outlook is due to better-than-anticipated medical cost performance," Rex said in the report. "The stock is trading at a 15% discount to the full group and a 25% discount to its most relevant peer group," the report noted, adding, "We view Anthem as one of the most compelling new stories to come along in our universe in years and believe that the multi-state dominant market share story will continue to gain ground."

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