Cigna: Anthem’s baggage makes marriage risky

Anthem Inc.’s takeover bid for Cigna Corp. turned hostile Saturday, but does that mean it’s doomed?

Wall Street certainly doesn’t think so. Investors bid up Cigna’s stock price by nearly 8 percent at one point Monday and pushed Anthem’s shares up as much as 5 percent.

And several analysts suggested Cigna has few options to evade Anthem short of finding another buyer.

But after 10 months of courtship, Cigna’s board of directors certainly made Anthem sound like a risky marriage partner in laying out their reasons for unanimously rejecting Anthem’s latest, $47 billion offer. (Anthem, earlier, blamed the stalled negotiations on Cigna’s directors and executives efforts to hold on to leadership in the combined company.)

Specifically, Cigna’s leaders noted that Anthem’s profits have gone down over the past five years due to “a lack of a growth strategy” while profits from its operations have risen by more than 80 percent.

Also, Cigna noted that Anthem is a defendant in a class-action lawsuit that accuses all Blue Cross and Blue Shield plans nationwide of engaging in a conspiracy to inflate health insurance premiums by limiting competition.

Publicly, Anthem has said the lawsuits are a groundless challenge to the well-established nature of the Blue Cross and Blue Shield Association, which allows only one insurer per state to use one of those brands. But privately, Anthem CEO Joe Swedish has expressed “significant concerns,” according to Cigna.

“These lawsuits, which recently survived a motion to dismiss, have enormous consequences for the BCBSA and could redefine the market for all of its member companies,” wrote Cigna CEO David Cordani and Cigna Chairman Isaiah Harris, in a letter to Anthem’s board of directors on Sunday. “Indeed, Mr. Swedish has indicated significant concerns to us about the status of the pending litigation, including the joint and several liability that may be imposed on Anthem, the largest member of the BCBSA. Given the critical nature of this litigation and the potential for value erosion to the combined company, we are concerned that you have not addressed this risk.”

When asked about these lawsuits during a conference call Monday, Swedish said he is optimistic about how the lawsuits will turn out and is confident Anthem can acquire Cigna without much impact from the lawsuits.

“It's hard to predict where legal process will take us, but we're very optimistic regarding the outcome and we believe we'll very effectively manage our way to a good end regardless of that outcome,” Swedish said, adding later that “we’ve been totally dialed into the litigation and obviously, if it was some substantial effect that would be very problematic, obviously we would probably have backed off [the deal with Cigna].”    

Cigna also raised concerns about how its combination with Anthem would affect Anthem’s standing as a member of the Blue Cross and Blue Shield Association. The group requires its members derive two-thirds of their revenue from Blue-branded businesses.

Cigna’s 2015 revenue is expected to be $38.2 billion, according to a survey of analysts by Thomson Reuters, with Anthem’s expected to be $78.2 billion, not all of which comes from Blue Cross health plans. That means the combined companies would have slightly more than one-third of their revenue from non-Blue businesses.

“We have not been able to validate that a combination of Cigna and Anthem could be integrated successfully under the BCBSA rules, and the stakes are too high and the penalties too great to move forward without that validation,” Cigna’s Cordani and Harris wrote in their letter. “Indeed, you terminated certain prior discussions due to this very issue, and you have yet to adequately address our well-founded concerns.”

But Wayne DeVeydt, Anthem’s chief financial officer, said Monday that’s a problem that can be dealt with easily.

“We would rebrand in our current Blue states that [Cigna] business Blue, which would assist us with that” requirement of the Blue Cross and Blue Shield Association,” DeVeydt told investors during the conference call. He noted that Anthem did exactly that after its 2013 acquisition of Virginia-based Amerigroup Corp.

Cigna also laid the blame for the massive data breach securely on Anthem’s shoulders, rather than the highly sophisticated hackers that Anthem blamed. Cigna’s leaders also said Anthem has done little to restore its consumers’ trust since announcing the breach on Feb. 4. Nearly 100 lawsuits about the breach have been filed against Anthem since then.

“Trust with customers and providers is critical in our industry, and Anthem has yet to demonstrate a path towards restoring this trust,” Cordani and Harris wrote. “We need to understand the litigation and potential liabilities, operational impact and long-term damage to Anthem’s franchise as a result of this unprecedented data breach as well as the governance and controls that resulted in this system failure.”

A recent survey of customers actually showed that Anthem has regained a fair bit of trust via its response to the breach.

But even with all that, analysts noted that Cordani and Harris still ended their letter by saying the proposed deal with Anthem has “the potential for shareholder value creation.” And analysts said it would be difficult for Cigna to resist an offer by Anthem that gives its shareholders an immediate 35-percent turn on their shares.

“Unless there is a competing bid from another party, we think it’s hard to picture a scenario where Anthem’s efforts are not successful,” wrote Chris Rigg, an analyst at Susquehanna Financial Group, in a research note. Referring to Anthem and Cigna by their ticker symbols, he predicted that “eventually the CI board will be able to find common ground with ANTM given that doing nothing would appear to carry substantial fiduciary and reputational risks.”

However, Barclays Capital analyst Joshua Raskin said he suspects Cigna is talking to a second suitor, based on Cigna’s slow responses to Anthem’s bids and Anthem’s request for a two-week “exclusivity period.”

“We see little chance that Cigna remains independent in the long term,” he wrote in a note to investors. “It would be hard for us to imagine Cigna shareholders (and we have spoken to enough of them) being satisfied with the alternative (remaining independent). We believe that pressure on Cigna's board is inevitable and likely begins now. For us, the question is more of a ‘when’ then an ‘if.’”