Humana Inc.

Managing a Changing Business

Ashutosh Dash
Humana The Issues

Identify the need for Restructuring

Identify alternative approaches

Correctly choose the alternative based on value gains

Analyze interaction between Strategy and Policy

Identify the need
for Restructuring
Restructuring - For Risk Management
Response to external changes
- Increased competition
- Policy changes
- More efficient technology
- Emergence of new markets
- Emergence of new products
- Demographic Changes
- Business cycles
Humana - Need for Restructuring

Integrated strategy is no longer profitable

No longer it control patient flows and occupancy rates

Hospitals and health plan businesses seems incompatible

Success of HMOs comes at the expense of hospitals

Humana hospitals not referred by other HMO competitors

Deteriorated relations between Humana and physicians

Patient Flows Synergy that reversed
Kaiser Permanente A Comparison
Kaiser, unlike Humana, is a nonprofit organization

Contents to operate hospitals as cost centers

Started out as a managed care provider, and later entered

the hospital business

The ratio of health plan enrollees to hospital beds was

much more favorable for Kaiser
In 1992, ratio was 851:1 for Kaiser, and 99:1 for Humana
Problems with unbundled business
Hospitals HMO
Severe excess capacity,
Declining operating
margins,
Unfavorable shifts in the
patient mix
Cost control of HMOs
Rapid growth in total
HMO enrollment
High growth does not
necessarily translate into
high profitability
High administrative cost
and medical loss ratio
Growth for acquisitions
Identify Alternative
Approaches
Forms of Restructuring

Mergers & Acquisitions

Demergers
Spin Off
Split Up
Split Off
Divestures
Carve outs
Buy-Back
Capital reduction
Choosing Appropriate Restructuring
Choice heavily influenced by the following:
Parents need for cash
Degree of operating units synergy with parent
Potential selling price of operating unity

Implications:
Parent firms needing cash
more likely to divest or
engage in equity carve-out for operations
Parent firms not needing cash
more likely to spin-off units exhibiting low selling prices and
synergy
Parent firms with moderate cash needs
likely to engage in carve-out when units selling price is low
Tax Issues in Restructuring

Central Tax
Issue

Recognition Non-recognition
Event Event

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Tax Issues in Deals
Business Combination or Demerger may be:
A taxable deal
Tax-free transaction

Tax free so long as certain statutory and judicial conditions

are satisfied

In taxable transaction, selling company realizes a taxable

gain or incurs a deductible loss

In tax-free event, no immediate tax effect but tax

consequence to each individual is deferred till disposal
Taxable and Non taxable structures
Taxable Transactions Non Taxable Transactions

Statutory cash Mergers Statutory Stock Mergers (Type A

Reorganization)

Purchase of Stock with Cash Stock for Stock purchase (Type B

Reorganization)

Purchase of Assets with Cash Stock for Asset purchase (Type C

Reorganization)

Triangular Statutory Cash Merger Triangular Statutory Stock Merger (Type

G & H Reorganization)

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 Choose
Alternative Based
on Value Gains
 Value in case of Divesture

EBITDA Multiple
Proceeds from Divesture 824.5 6 4947
Un-depreciated value of PPE 2573 80% 2058.4
Less Medicare Recapture 584
Capital Gain 2304.6
Tax 783.564

Proceeds from Divesture 4947

Less Tax 783.564
Less Medicare Recapture 584
3579.436
How Spin off Can Create Value?
Investors put a higher value on "pure plays
Existence of a stock market inefficiency
Humana's price-earnings multiple:
Before the spinoff (10x)
Average multiple for stand-alone HMOs (26x)
Can increase the firm's combined cash flows because of
improved management incentives
Eliminating the negative synergies that arose under its
integrated strategy
Value based on Spin-Off

HOSP HP CORP
EBITDA 904.00 100.00 (159.00)
79.50 79.50 159.00
824.50 20.50
EV/EBITDA 9.4 9.2
EV 7750.3 188.6 7938.9
Debt 792
Equity value 7146.9
Value per Share 45.18
Value based on Spin-Off
HOSP HP CORP
EBITDA 904.00 100.00 (159.00)
79.50 79.50 159.00
824.50 20.50
Interest Expenses 193.00 (36.00) (123.00)
(123.00) 123.00
70.00 (36.00) 0.00
Dep 210.00 26.00 20.00
10.00 10.00
220.00 36.00

Pretax Income 534.50 20.50

Tax 213.80 8.20
EAT 320.70 12.30
EPS 2.03 0.08
P/E Ratio 15.00 26.00
Value Per Share 30.41 2.02 32.43
Equity Value 5130.30
What Happened???
Spun off hospitals business renamed Galen Health Care
Long term debt ($690 million) was assumed by Hospitals
for financial flexibility of health plan
Agreement to maintain business relationships for 3 years
Hospital to provide services to members of Health Plans at a
concessional scheme
Health Plans required to use Hospitals' facilities by a
minimum guaranteed annual amount or penalty
Give hospitals the right to match the rates of any other
hospital services provider that Health Plans wished to use