Big fish gets away but WellPoint is still set on growing with acquisitions. (Up Front).

WellPoint Health Networks Inc. went public in 1993 and was the nation's first conversion of a nonprofit Blue Cross to a for-profit structure. To fuel its own growth--and tremendous success to date--the Thousand Oaks-based company has largely relied on acquisitions of other Blues around the country.

Earlier this month, WellPoint hit a stumbling block in this tried and true strategy when its nearly $1.4 billion deal to buy CareFirst BlueCross BlueShield was scuttled by regulators in Maryland, where CareFirst is located.

There are still about 40 non-profit or mutually owned Blue Crosses nationwide that could be acquisition targets for Thousand Oaks-based WellPoint or its competitors. But the failure of the CareFirst deal, and its unlikely revival, puts a spotlight on the ongoing difficulty in getting these complex acquisitions done. "We go into these deals with our eyes wide open," said Ken Ferber, the company's spokesman.

WellPoint, once a subsidiary of Blue Cross of California, has posted impressive growth in its existing operations, but the inability to complete the CareFirst deal leaves the company with a hole in its plans to cover the Mid-Atlantic region.

"It's a strategic disappointment," said Clifford Hewitt, an analyst with Legg Mason Wood Walker.

Since going public in 1993, WellPoint has acquired other formerly nonprofit Blues plans, including Blue Cross and Blue Shield of Georgia in 2001 and Blue Cross and Blue Shield of Missouri last year.

The Blues plans are among the oldest health insurers in the nation and their roots date back to prior World War II. But they have been converting to for-profit public status over the past decade to better compete in the tough managed care marketplace.

In Maryland, WellPoint attempted to buy CareFirst, which had not yet made the conversion. That meant regulators had to approve a conversion and acquisition all in one package.

Severance payouts

WellPoint's reputation as a tough negotiator on reimbursement rates led to early opposition from medical care providers. But what really killed the deal was the perception that CareFirst's $1.4 billion asking price was too low--and approved by a board more interested in lining its own pockets with $117 million in severance payments than achieving the highest sale price.

Maryland Insurance Commissioner Steven Larsen cited those concerns in rejecting the sale. The Maryland General Assembly can overturn the decision and WellPoint can appeal it, but analysts believe the deal is dead.

"The board club went amok in the worst way," Hewitt said. "The bonuses stuff was absurd. It just so alienated people and everything else just spiraled down from the ruckus it created."

Analysts say there undoubtedly will be future acquisitions of the remaining Blues that are not publicly traded. But it's also likely that, given the CareFirst setback, future sales will not take place until the Blues convert to for-profit status on their own, perhaps with a few years of operations in between any sale.

"It's a much more transparent process," Hewitt said.

As a result, WellPoint may have to rely on internal growth for a while.

The company is experiencing rapid growth in the Southeast, where its Georgia Blue purchase is working out well. It has also diversified the last few years into businesses that do not directly involve managing risk, including its Precision Rx unit in Texas, which fulfills pharmacy orders.

Such outside businesses are expected to become more important for health insurers, helping shield them from the ups and downs of health care costs, which directly drive premiums.

Still, WellPoint says that expanding into the Mid-Atlantic and elsewhere through acquisitions remains in its future plans. "Acquisitions are part of our growth," Ferber said.

Stock price decline

Like other big managed care insurers, WellPoint has seen its stock drop over the past few months, from a high near $90 a share in October. It was trading around $70 a share last week.

But the drop has been driven more by fears that the latest round in premium price increases, which have hit double-digit rates, will meet resistance from employers and employees.

In such a scenario, WellPoint's impressive profit margins could get squeezed.

Net income for the fourth quarter ended Dec. 31 was. $180 million ($1.18 per diluted share), compared with $109.9 million (83 cents) for the like period a year earlier. Revenues were $4.6 billion, up from $3.4 billion.

Analysts don't agree on whether WellPoint needs further acquisitions in order to repeat its past performance. Wall Street has gone down this road before with the expansion-minded insurer, which saw three large acquisitions fuel its nearly 50 percent net income growth in 2002.

Some deals have fallen apart over the last few years, including its 2000 effort to take over No. 1 insurer Aetna Inc.

As a result, analysts hadn't factored the CareFirst deal into future earnings, nor do many see the deal as critical to WellPoint's short-term future. The company is still digesting its most recent acquisitions in Missouri and elsewhere, which are expected to help fire a projected 15 percent earnings growth this year.

"I don't believe the market is looking for acquisition-driven growth," said Michael Baker, an analyst with Raymond James & Associates.

On the other hand, there's a belief among some analysts that there are still acquisition opportunities for WellPoint, and that some lessons learned in Maryland could be well applied elsewhere to smooth things along.

"The private Blues face a challenge with respect to access to capital. How do they meet the new challenges they face? Certainly one approach would be to team up with a WellPoint," Baker said.

WellPoint Health Networks Inc.

YEAR (Dec. 31)                    2002   2001

Revenue (billions)               $17.3  $12.4
Operating Expenses (billions)       16   11.6
Operating Income (millions)    1,278.9  823.2
Net Income (millions)            703.1  414.7
Earnings Per Share               $4.67  $3.15

SUMMARY

Business: Health care insurer

Headquarters: Thousand Oaks

CEO: Leonard Schaeffer

Market Cap: $10.6 billion

Divident Yield: 0.2%

Total Liabilities: $7.3 billion

P/E Ratio: N/A

Long-Term Debt: $1 billion

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