Humana Case
The purpose of this memo is to analyze Humana’s business model and its spin-off solution.
We think Humana’s problems were severe enough to implement restructuring plans within the company. First of all, Humana’s administrative cost ratio was 16.1% and medical loss ratio stood at 85.9% (increased from 84.4% in 1991). The stock price was declining from $34.5/share in May 1991 to $21.63 in May 1992. In addition, the entire hospital industry is suffering losses in the long-term because of increases in operating costs, decreases in average hospital stays (occupancy rate declining to 47%, national average occupancy rate was 69%), and growing competition. The margin is diminishing and the PE ratio is lower in both industry averages. Spin-off is ideal since the hospital industry is shrinking and Humana’s profit from hospital starting to decline. A decision made early will still allow Humana a higher valuation on hospital business.
The separate income statement is listed below. As presented, the after-tax net income of Humana Hospital and Health Plan are $314M and $ 41M. After we compare the asset sizes of comparable companies, we decided that the PE ratio for the Hospital business should be 13.0x, equal to that of National Medical Enterprises, as they are closer on the asset size. The PE ratio for Health Plan business should be 17.0x, equal to the average of United Healthcare and U.S. Healthcare, for the same reason. Thus, the value of these two businesses separate will be $4,087M and $694M. The Market value using current PE ratio for the whole Humana Company is $3,550M. Therefore, a spin-off of these two segments (assuming tax rate is 36%) will create an extra value of approximately $1,231M. Humana should assign most of its debt to the hospital business and keep sufficient cash in the health plan segment. According to the exhibits, the proportion of debt distributed to hospital and health plan is 5:1. Health Plan business could expand itself and enjoy further profit
We think Humana’s problems were severe enough to implement restructuring plans within the company. First of all, Humana’s administrative cost ratio was 16.1% and medical loss ratio stood at 85.9% (increased from 84.4% in 1991). The stock price was declining from $34.5/share in May 1991 to $21.63 in May 1992. In addition, the entire hospital industry is suffering losses in the long-term because of increases in operating costs, decreases in average hospital stays (occupancy rate declining to 47%, national average occupancy rate was 69%), and growing competition. The margin is diminishing and the PE ratio is lower in both industry averages. Spin-off is ideal since the hospital industry is shrinking and Humana’s profit from hospital starting to decline. A decision made early will still allow Humana a higher valuation on hospital business.
The separate income statement is listed below. As presented, the after-tax net income of Humana Hospital and Health Plan are $314M and $ 41M. After we compare the asset sizes of comparable companies, we decided that the PE ratio for the Hospital business should be 13.0x, equal to that of National Medical Enterprises, as they are closer on the asset size. The PE ratio for Health Plan business should be 17.0x, equal to the average of United Healthcare and U.S. Healthcare, for the same reason. Thus, the value of these two businesses separate will be $4,087M and $694M. The Market value using current PE ratio for the whole Humana Company is $3,550M. Therefore, a spin-off of these two segments (assuming tax rate is 36%) will create an extra value of approximately $1,231M. Humana should assign most of its debt to the hospital business and keep sufficient cash in the health plan segment. According to the exhibits, the proportion of debt distributed to hospital and health plan is 5:1. Health Plan business could expand itself and enjoy further profit