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,  Rapid growth in total
 Declining operating HMO enrollment
margins,  High growth does not
 Unfavorable shifts in the necessarily translate into
patient mix high profitability
 Cost control of HMOs  High administrative cost
and medical loss ratio
 Growth for acquisitions
 Identify
Alternative
Approaches
The Form of Corporate Restructuring
 Restructuring Activity
 Potential Strategy

 Corporate Portfolio
 Redeploy Assets
 Mergers, Break-Ups, & Spin-Offs
Restructuring
 Balance Sheet  Acquisitions, divestitures, etc.

 Assets Only

 Increase leverage to lower cost of capital or as a

 Financial Restructuring takeover defense
(liabilities only)

 Divestitures, widespread employee reduction, or

 Organizational Restructuring reorganization
Alternative Forms of Restructuring

Corporate
Restructuring

Portfolio Restructuring Financial

Restructuring

Entry Exit
Strategy Strategy Debt &
•Mergers •Spin Off Equity
•Acquisitions •Split Off Restructuring
•Divesture •IPO/Buyback/
Stock
Split/LBO
Forms of Restructuring

 Mergers & Acquisitions

 Demergers
Spin Off
Split Up
Split Off
 Divestures
 Carve outs
 Buy-Back
 Capital reduction
Spin-Offs
Stage 2
1

Parent Parent Firm Parent Parent Firm

Firm Shareholders Firm Shareholders

Subsidiary Stock Parent Shareholders Subsidiary

Paid to Shareholders Own Both Parent & Independent
Subsidiary As Dividend Subsidiary Stock of Former
Parent
Equity Carve-Outs
Initial Public Offering Subsidiary Equity Carve-Out

Private Firm Sells Parent Firm Sells Cash Public/Private

A Portion of Its Equity A Portion of Its
Equity Markets
to the Public Subsidiary Stock
to the Public

Stock Cash

Subsidiary Stock
Public/Private
Subsidiary of
Equity Markets
Parent Firm
Tracking Stocks
Parent Firm Value of the
Tracking Stocks
Parent Common Tracking Stock
Issued by the
Sub 1 Tracking Stock Depends on the
Parent Firm
Sub 2 Tracking Stock Performance of
Subsidiary
Sub 3 Tracking Stock

Subsidiary 1 Subsidiary 2 Subsidiary 3

Split-Offs
Stage 1 Stage 2

Parent
Former
Parent Stock Parent Firm Parent
Parent Firm
Firm Shareholders Firm
Shareholders

• Subsidiary stock
Subsidiary
Subsidiary Stock now held by former
Independent
Subsidiary parent shareholders.
• Parent has no of Former
Parent
relationship with former
subsidiary
Choosing Appropriate Restructuring
 Choice heavily influenced by the following:
 Parent’s need for cash
 Degree of operating unit’s 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 unit’s selling price is low
Tax Issues in Restructuring

Central Tax
Issue

Recognition Non-recognition
Event Event

18 08/30/2020
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)

20 08/30/2020
 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     846
Equity value     7092.9
Value per Share     44.84
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