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WellCare Health Plans (WCG)

May 4, 2010

This is the 4th in my series reviewing my major portfolio holdings

This position began as an idea borrowed from Berkowitz’s Fairholme Fund holdings in 2008.

Background
WellCare  “provides managed care services for government-sponsored healthcare programs in the United States. The company offers Medicaid and Medicare plans, including health plans for families, children, aged, blind, and disabled, as well as prescription drug plans…. As of December 31, 2009, WellCare [..] had approximately 1,349,000 Medicaid members and approximately 972,000 Medicare members. The company was founded in 1985 and is headquartered in Tampa, Florida.” Between 2004 and 2007 the company was quite successful in growing earnings and this was reflected in the share price which increased from the low $20s to over $115 per share.

Then the bombshell hit. WellCare offices were raided by the FBI in October of 2007 and the company was subsequently charged with accounting irregularities and fraud. In response, the stock dropped to under $30 per share almost overnight. I first became interested when I noticed that the Fairholme Fund had picked up a large chunk of WCG just after the FBI raid and the share price meltdown. Naturally, not really knowing anything about healthcare I decided the better part of valor was to wait a bit and see what was going to happen. The share price bounced around between 30 and 40 for the next several months; by April it seemed to me that the share price had made its bottom and was beginning to climb so I began to accumulate a few shares in the low forties. But the problems at WellCare weren’t so easily solved, and it became clear by the Summer that a settlement with the government was going to take much longer than I, at least, had originally anticipated. With the market meltdown in the Fall of 2008 and no announced settlement to the government fraud case in sight, WCG shares traded down below $10. Now, at that price, the investment case for WCG looked a lot stronger to me; with book value of around $21/share (mostly in cash) the stock was trading at less than 50% of book. So I purchased more in late Feb. 2009 and again in the 2nd quarter, bringing my cost basis down to around book value (yes, I waited too long for my final purchases).

So what has happened since? The anticipated settlement with the government has now been finalized with financial payments to be made that are not crippling to the company. However, after trading up to the upper $30 in December, lower-than anticipated guidance for 2010 provided in January sent the share price back down to below $30, where it has been languishing despite the market rally. Furthermore, in April a Director who was head of the audit committee was not renominated to stand for the board, and she had some unkind words to say about the other Board members. We’re obviously still not out of the woods yet.

Valuation and Sell Target
This is not one of my normal value investments. The rationale was regression to the mean rather than price to book; I originally felt that all those portfolio managers who dumped the stock at $30 because the company was under investigation, would find it attractive again at $60 when the investigation was resolved, the settlement made and operations returned to normal. Obviously it hasn’t worked out that way.. yet. Earnings power has not returned to pre-scandal levels, and in the interim the playing field has changed with the new Obamacare legislation. I think this latter should have a positive impact on WCG, but what do I know?

OK, with things not working out according to my original game plan, I needed some new idea of what my WCG shares might actually be worth. A little analysis was in order. Where is WCG trading in relation to its peers? I’m a simple guy so a quick and dirty analysis would have to do. I’ve included below a comparison table showing where WCG is trading in relation to United Healthcare, Wellpoint, Coventry Health and Amerigroup. These companies are not all exactly comparable to WCG as they have a different size (particularly UNH and WLP) and have a different mix of public vs. private members. But what jumps off the page is that WCG trades at a lower multiple of revenue (obviously because it is less profitable), and thus has more potential upside. So, if I assume margins at WCG will (eventually) return to levels at the other healthcare management companies, I come up with a target price of somewhere in the $45 to $55 range. Maybe too simplistic a methodology, but given the continued uncertainties around the operations and governance at WCG, the economy in general and healthcare in particular, I don’ think any complex analysis will provide more insight. I will be reviewing the status of this position by YE, and will tend to liquidate if I don’t see operational improvement.

WellCare Value Analysis        
             
      WCG UNH WLP CVH  AGP
             
Share Price $28.63 $30.31 $53.80 $23.74 $36.24
Shares out (mil) 42.3 1160 443.9 148 51.1
Mkt. Cap (bil) $1.2 $35.2 $23.9 $3.5 $1.9
             
Book value(bil) $0.9 $24.4 $24.5 $3.7 $1.0
BV/Share $21.47 $21.04 $55.28 $25.09 $19.44
P/BV 1.3 x 1.4 x 1.0 x 0.9 x 1.9 x
Cash/share $28.83 $9.58 $48.54 $12.57 $12.59
             
Debt/Equity 0 0.4 0.3 0.4 0.2
             
Rev/share $164.50 $75.50 $128.60 $94.89 $100.45
Rev/$ invested $5.75 $2.49 $2.39 $4.00 $2.77
             
Last year P/E 32 9 6 15.1 12.7
Forward P/E (Yahoo) 12 9 8.7 10.2 13.9
             
Target $45-55/share      
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