Seeking Alpha • Jul 19
LHC Group: UnitedHealth Merger Is Worth Playing
UnitedHealth’s ongoing acquisition of LHC Group is an interesting merger arbitrage setup, potentially offering an annualized return of 10%.
The spread has recently widened as the transaction has attracted the FTC’s attention.
The merger still seems likely to close - both companies have a low overlap, the home healthcare market is highly fragmented and the Humana-Kindred merger is a closely comparable transaction.
The main risks are antitrust concerns over vertical integration and legal challenges to UnitedHealth’s ongoing merger with Change Healthcare.
This is one of the ongoing large-cap merger arbitrage cases where the spread has recently widened. Healthcare and insurance giant UnitedHealth Group (UNH) is buying in-home healthcare company LHC Group (LHCG) at $170 per share. Board/shareholder approvals are already in-the-pocket. The only remaining hurdle is antitrust approval.
Until recently, the market was not pricing in any regulatory risk as the spread was around 2%. In June, however, the merger received a second information request from the FTC. Since the news, the spread has jumped and is currently at 5%. In early July, rumors appeared that the FTC’s probe is focused on workers’ pay. Regulatory investigation is currently ongoing and the FTC will have 30 days to finish the review once the companies submit all the required information.
Red dot represents FTC’s second request date. Yellow dot is where rumors appeared that FTC’s request is focused on labor pay.
FTC’s inquiry comes in light of several industry developments.
Firstly, UNH’s other ongoing $13bn merger with Change Healthcare (CHNG) has received pushback from the DoJ. The trial is set for August. However, CHNG operates in a different industry (medical billing software) than LHCG and the UHN-CHNG transaction has a much higher business overlap compared to UNH-LHCG merger.
Secondly, since Joe Biden’s executive order on promoting competition in 2021, antitrust regulators have been putting increasing attention on healthcare mergers, highlighting impact on workers’ wages and the degree of vertical integration. These two concerns could be at play in the LHCG-UNH transaction. Also, as of May, the FTC has shifted to a majority-democratic commission, possibly pointing to tighter regulatory scrutiny.
Despite these risks, I see several reasons why the LHCG merger is likely to receive regulatory clearance:
UNH and LHCG have a low service overlap.
The home healthcare market is highly fragmented.
The Kindred-Humana merger is a comparable transaction in the home healthcare space.
Recent FTC ruling history suggests that healthcare mergers are blocked due to geographical overlap/dominant market shares - largely not applicable to UNH-LHCG. Moreover, seemingly no mergers were blocked solely on labor pay grounds.
Let’s go through these one-by-one.
Limited Business Overlap
LHCG operates in the post-acute healthcare market. The primary focus is on home-based healthcare services which have historically made a lion’s share of revenues at ~80%. This includes two reportable segments - home health (~70%) and home-/community-based care (~10%). The company operates home nursing agencies through which it provides post-acute nursing, medically-oriented social services and therapy. Other segments (~20% of revenues) are hospices, facility-based healthcare services and other healthcare businesses.
Meanwhile, UNH is a vertically-integrated multinational company - it runs both health insurance (UnitedHealthcare) and health services (Optum) businesses. The Optum arm provides a continuum of healthcare services, including primary care, virtual care, behavioral health and ambulatory surgery. Even so, the company’s presence in the post-acute in-home care market has been limited. Apparently, ever since the pandemic, UNH has sought to expand the segment. Still, some overlap with LHCG remains - UNH launched its own service HouseCalls as well as acquired start-ups Landmark Health and naviHealth.
HouseCalls in an annual in-home medical assessment and not a post-acute care service. Having said that, the number of patient visits in 2021 were at ~2.1m compared to 12m+ patient encounters at LHCG, though the latter include hospice patients.
NaviHealth is a software business. The company operates a platform which helps hospital systems and healthcare providers manage clinical decision-making and track patient data. It should be noted that the focus is also on post-acute healthcare services.
Landmark Health provides in-home care, however, the focus is exclusively on the sickest and most complicated patients. Services are offered in addition to regular primary care providers, such as LHCG. As of 2019, the number of annual visits was at 400k.
Home-Care Market
The in-home care market in the US is highly fragmented. To illustrate this, the largest market share captured by Kindred at Home (not publicly-listed) in recent years has been stable at only around 6% while other largest peers (Amedisys and Encompass) have occupied only ~4%-~5%.
Company
LHCG
AMED
EHC
Kindred at Home
Market Cap
5.0
4.1
4.9
Enterprise Value
5.8
4.5
8.0
FY2021 Home Care Revenues ($bn)
1.6
1.4
0.9
Market Share
4.4%
5.0%
3.9%
6.0%
Sources: Company filings and HealthCare Appraisers.
LexisNexis
Visually, LHCG (top-right) appears to cover similar geographies as the largest peers Kindred, Amedisys and Encompass:
AMED 8-K Filing, LHCG Investor Presentation, EHC Investor Reference Book, Kindred Healthcare Investor Presentation (Kindred acquired Gentiva in 2015)
Looking more specifically, LHCG’s share of the number of home care agencies in several states is significant at ~70% in Mississippi and ~50% in Kentucky. However, these areas have relatively low numbers of total home care providers. Plus, total agency number includes only Medicare-registered providers whose count stands at ~11k compared to a rough estimate of ~35k+ including non-licensed agencies. With this in mind, the merger is unlikely to result in UNH obtaining any alarming market power other than in several specific geographies where divestitures, if needed, could be reasonable to expect. This makes any antitrust pushback very unlikely.