David Einhorns Greenlight Capital made a big bet on a pair of managed-care companies leading up to the Supreme Courts historic decision regarding the Patient Protection and Affordable Care Act or Obamacare in late June.
The hedge fund manager told clients in the firms second-quarter letter that it established substantial new positions in Cigna and Coventry Health Care, noting that the entire sector had been battered in anticipation of the High Courts ruling.
Investors had been concerned that Obamacare would force costly regulations on managed-care companies beginning in 2014 and would require healthcare coverage to everyone, including those with preexisting conditions.
Of course, the individual mandate would no doubt result in additional customers as well, which would boost the managed-care companies.
So far, Greenlights bet has not paid off.
The firm told clients in its letter that it paid $45.42 per share for its stake in Cigna. The stock, however, is trading around $41 or so, after trading as high as $49.43 as recently as April 2.
Greenlight paid $31.22 for its Coventry shares, slightly less than their current $32 price.
Einhorn, however, is not betting his money on these stocks based on whether or not Obamacare survives or is dismantled or trimmed. He sees them also as value plays.
For the most part, these companies have unlevered balance sheets and trade at single-digit P/E multiples on earnings that should continue to grow, the firm notes in its letter dated July 23, without specifying the size of the positions. They have no exposure to the European currency crisis, a possible Chinese slowdown or other cyclical headwinds.
Greenlight adds that although the stocks are cheap, there is additional unpriced upside should the elections change the political landscape, which could result in changes or outright repeal of Obamacare.
In the letter, Greenlight points out that Cigna has three divisions. Cigna HealthCare, which accounts for about 70 percent of profits; the recently bought HealthSpring, which Greenlight likes because it gets the company into what it deems to be the fast-growing Medicare Advantage program; and Cigna International, which provides insurance for individuals as well as insurance and administrative services to large companies and governments. According to Greenlight, Cigna International is growing by 20 percent per year. We believe that CI deserves a higher multiple because the plan administrative business is a service business that doesnt take risk, and the other divisions do not warrant discounted values, Greenlight states in its letter, noting it paid $45.42 per share for its stake.
Greenlight says Coventry, which serves the mid-Atlantic states, Midwest and parts of the south, offers commercial risk-based insurance and a growing business in the government-sponsored Medicare and Medicaid programs. The hedge fund points out the stock recently took a big hit when the company was forced to significantly reduce earnings guidance for 2012 due to a troubled three-contract to provide Medicaid coverage in Kentucky.
We believe the issues related to the Kentucky contract are manageable and finite, it tells clients, adding it expects to either break even or make money on the contract in 2013. Greenlight paid $31.22 for the stock.
The Greenlight Capital funds lost, on average, 3.2 percent in the second quarter, dropping its year-to-date gain to 3.4 percent, net of its 2 percent management fee and 20 percent performance fee.
The hedge fund firm said three of its biggest losers in the second quarter were big gainers in the first quarter the French company Arkema, General Motors and its yen position.
It also suffered significant losses on its investment in Marvell Technology Group.
Most of its gains came from shorts, especially Green Mountain Coffee Roasters.