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PRU HEALTH CARE OPTIONS EYED

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NEWARK, N.J.-Prudential Insurance Co. of America could face a daunting challenge in finding a buyer if it decides to sell its unprofitable health care business.

While Prudential denies its health care operation is even up for sale, the general consensus in the market is that the insurer is anxious to get out of the business, on which it is estimated to have lost more than $100 million on a premium base of $6 billion last year (BI, Oct. 6).

Consultants say that while a Prudential sale to another health care company would give employers one fewer managed care company to choose from, an acquisition could also result in a stronger vendor willing to commit more resources to customer service.

However, the most likely candidates to buy the business, which include Aetna Inc. and CIGNA Corp., already have their hands full absorbing other acquisitions.

The problems that these and other health care companies have had could sour Wall Street on another major acquisition at this time, some market observers say.

Other possibilities observers suggest include a regional player seeking a national base, breaking up the business geographically and selling it in pieces, somehow shrinking the business to a more digestible size, a management buyout, or its purchase by a third-party administrator.

The company itself has raised the possibility of the business being taken public through an initial public offering.

Prudential says it is concentrating for now on fixing up the business. "We've been saying the same thing for a long time, which is we can't control the rumors and speculation, but what we can say is we are focused on fixing the company, not selling it," said a spokesman, who noted Prudential appointed a new president and chief executive officer, Steve Shulman, to the health care unit in April.

"Steve is well into his turnaround strategy for the company, which is on course," said the spokesman. "We expect the company to be profitable in 1988."

However, he added, "The company is keeping all its options open, and those options could include accessing the capital markets to take the company public, merging or partnering with other health care companies, or other options, but that's not the focus of the company at this point."

"I'm not sure they are definitely up for sale," said Jack Doerr, national group benefits practices leader with Sedgwick Noble Lowndes in Chicago.

Although Prudential's hiring of an investment banker has been interpreted as the first step in a sales process, it could also be the first step in determining the value of the health care unit in order to do an IPO, said Mr. Doerr. "I think they're going to weigh their options," he said.

Meanwhile, those companies most likely to have the financial resources to buy the Prudential business, one of the nation's largest managed care operations, with 4.7 million covered lives under its managed care products plus another 2 million under its indemnity program, already have their hands full, observers point out.

Aetna, for instance, has blamed its lower-than-expected third-quarter earnings on a temporary glitch caused by its U.S. Healthcare Inc. acquisition. CIGNA Corp., which acquired Healthsource Inc. earlier this year, attributed its lower-than-expected earnings to higher-than-expected medical delivery costs and the general medical cost trend (BI, Oct. 6).

The rumor out there is that CIGNA might be interested in another acquisition, though, said Tom Billet, vp and national practice leader in Stamford, Conn., for the MEDSTAT Group, a health care information and consulting firm.

Stephen Parahus, senior consultant with the Kwasha Lipton Group of Coopers & Lybrand, who is based in Fort Lee, N.J., said CIGNA's acquisition of Prudential "would not surprise me. I think they'd like to be a bigger player in the managed care market, and I think having a great, big ready-made client base is a good way to do that."

"CIGNA or Aetna would be my first guess," said Michael LeConey, an HMO analyst with National Securities Inc. in New York. "They've got the money, they've put a lot of money to work in this field, there's an opportunity to really build a huge, huge position, and so I think they are more likely to do it than most."

An Aetna spokesman could not be reached to comment, and a CIGNA spokesman had no comment on the issue.

But Douglas L. Meyer, an HMO analyst with Duff & Phelps in Chicago, said Minneapolis-based United Healthcare Inc. "is probably one who'd be in the best position, given that they've done a similar-type acquisition before with MetraHealth, and also it's been a while since they've done one that significant, on that scale, anyway." A United spokeswoman had no comment.

In addition to Aetna and CIGNA, Mr. Meyer noted, PacifiCare still is working on its FHP International Corp. acquisition, while WellPoint recently acquired the group health and related life businesses of John Hancock Mutual Life Insurance Co. and the group life and health business of Massachusetts Mutual Life Insurance Co.

"They've all been busy, but nevertheless, you never know. The pricing might be such that even those that have their hands full might make a run at it," Mr. Meyer said.

Despite Prudential's underperformance, "it's a very large operation and would give a potential acquirer significant mass and scale in an industry where scale is becoming increasingly more important," said Mr. Meyer.

Other observers also point to the business' poor recent results. "Prudential has underperformed significantly over the last five years and does not show many signs of improving, so at a time when the industry is by and large very earnings-conscious and trying to improve overall margins. . .I think these larger players are probably going to approach that book of business with a little bit of caution," said Mark Jamilkowski, an analyst with Hartford, Conn.-based Conning & Co.

They are "not going to want to dilute earnings power or momentum" just for the sake of acquiring an available book of business, said Mr. Jamilkowski. "An acquisition for acquisition's sake is not a good acquisition," he added.

"There's not a lot of appetite right now among Wall Street investors for large acquisitions," given how previous acquisitions have performed to date, said Gary Frazier, managing director at Bear, Stearns & Co. in New York.

A non-profit organization could be interested, he said. In addition, a public company could step in if it was offered at a "real, real bargain-basement price" to minimize any concerns about earnings dilution or if the deal was structured so that earnings dilution was not a factor. It is also possible a buyer will not be found, said Mr. Frazier.

'I don't know that this is the year to sell a troubled HMO operation. A lot of HMOs have got problems already of their own," said Rob Mains, an analyst with Advest Inc. in Albany, N.Y.

"It doesn't seem like a propitious point in time for someone to step up to a huge acquisition, an acquisition of that size, kind of given where we are in the cycle and what recent history has shown," agreed MEDSTAT's Mr. Billet.

Other alternatives besides its purchase by a large national organization are possible, say observers. For instance, the buyer also could be a regional HMO "looking to become more of a national organization," said Patrick Finnegan, an analyst with Moody's Investors Service in New York.

Or, the business may not be sold right off, suggested Mr. Billet. "I think a likely scenario is they will shrink the business down quite a bit and then attempt to sell it." Another alternative, he said, would be to break it up and sell some pieces of it to different players.

A purchase by current senior management or by a TPA attracted by its substantial amount of self-insured business are possibilities as well, suggested Kwasha Lipton's Mr. Parahus.

Observers think health care buyers could be better off if Prudential sold the business. "There's a part of me that always thinks it's a bad idea when the community of health care providers gets smaller, because it reduces the number of choices employers have," said Mr. Parahus. It could also be difficult for a health care buyer who happens to have "bad blood" with whomever takes over the business.

But on the upside, "many of the other managed care vendors probably have a little bit better handle on how to operate in the market," he said. If Prudential's business can be sold off to another company that could commit more resources "to build a more efficient managed care machine," that would accrue to the benefit of all its customers, said Mr. Parahus.

Assuming employers are still left with an adequate number of options for plans to offer their employees, "I think the options become stronger," said Sedgwick's Mr. Doerr. "A new owner will be financially stronger, they will probably be better-focused and they probably will have a delivery mechanism in place that might be better," he said.

"Probably a lot of major employers that bought into Prudential four, five, six years ago are disappointed with their performance, really expected them to be a leading national player and are disappointed with what the results have been," commented MEDSTAT's Mr. Billet.

"The national kind of employers that I work with, most of them tend to use a lot of regional and local plans, so I'm not sure that they're really going to be losing options for coverage the way they might have several years back," he said.

The impact on health care buyers would depend upon who the particular acquirer is, commented Ken Jacobsen, national health practice leader based in Atlanta for The Segal Co. Some mergers, for instance, which involve joining totally different philosophies or management styles could represent a strain on employers, while others are accomplished more easily.

Another issue, he said, is whether the "bigger is better" approach ultimately serves the client "or is it simply better for shareholders and management of the corporation?"