PacifiCare HMO to Make Bid for Bankrupt Maxicare

In a bold bid to boost its already large HMO membership in Southern California,PacifiCare Health Systems Inc. said Thursday that it will make an offer to acquire bankrupt Maxicare Health Plans.

Financial details of PacifiCare’s proposed buyout of the Los Angeles-based health maintenance organization were not disclosed.

The surprise offer comes five days before Maxicare will present a disclosure statement to the federal bankruptcy court in Santa Ana. The statement’s approval is crucial for Maxicare’s reorganization and expected emergence from Chapter 11 bankruptcy.

Maxicare officials said they would consider the unsolicited offer, but were clearly unhappy with its timing.

“We have made it clear for more than a year that Maxicare is not for sale, so we are, quite frankly, puzzled by the timing of this announcement, which comes just two business days before a crucial public hearing on our reorganization efforts,” said Peter J. Ratican, chairman and chief executive of Maxicare, in a prepared statement.

If consummated, the merger would make Cypress-based PacifiCare one of the Southland’s largest HMOs with 580,000 members in the region and 956,000 nationwide. Kaiser Permanente, with more than 2 million members in Southern California, is the largest HMO serving the region.

The combination could be a two-edged sword for consumers. Industry analysts said the merger could improve the efficiency of the HMO’s health-care delivery by providing greater resources. But the reduced competition could also mean higher prices.

Wayne Lowell, PacifiCare’s chief financial officer, said the company had informed Ratican of the forthcoming buyout proposal, which would be made by this morning. He said the offer was expected to be a starting point for extended negotiations.

“We believe Maxicare would make an excellent strategic addition for PacifiCare,” Terry Hartshorn, PacifiCare’s president and chief executive officer, said in a statement. “Maxicare’s largest single membership component is in California, which also represents our largest geographic concentration of membership.”

PacifiCare officials said that 130,000 of Maxicare’s 320,000 members are in California, where about 450,000 of PacifiCare’s 638,000 members also are located. The acquisition would boost PacifiCare’s total membership by more than 50%.

Maxicare also has HMO operations in Indiana, Illinois, Wisconsin, Louisiana, South Carolina and North Carolina. PacifiCare also does business in Oregon, Oklahoma, Texas and Washington, and has an insurance subsidiary licensed in 33 states.

While PacifiCare has prospered as a regional operator, Maxicare expanded rapidly as a national firm that sought out large corporate clients looking for a single HMO for their scattered employees. But after two acquisitions of failing HMOs and two years of losses, Maxicare sought protection in March, 1989, from its creditors under Chapter 11 of the bankruptcy law.

Ratican said he expects Maxicare to emerge from bankruptcy proceedings later this year. While he has an obligation to creditors, stockholders and clients to consider any offer, Ratican said he still expects Maxicare “to be an aggressive competitor of theirs (PacifiCare) in the 1990s.”

PacifiCare’s interest in Maxicare, he said, “is an indication that they think this management has turned the company around.”

Ratican said he had previous discussions with PacifiCare about possible sale of a few Maxicare operations. But those discussions, which ended in March, 1989, were unsuccessful.

While no financial details were released, Ratican noted that Cigna, a diversified insurance company based in Philadelphia, recently announced it would pay $777 million to buy Nashville-based Equicor, which has 450,000 members in 19 HMO plans.

Alan Hoops, PacifiCare’s chief operating officer, would say only that PacifiCare would expect to offer Maxicare’s creditors as much as they have been promised in Maxicare’s plan of reorganization.

The plan calls for creditors and shareholders to receive about $102 million in cash and $67 million in notes, common stock and warrants.

Industry analysts say that the proposal by PacifiCare was out of character for the company, known for its conservative policies. It has produced consistent profits and built its membership through internal growth rather than acquisitions.

“PacifiCare is a very consistent player that usually hits singles and doubles,” said Larry Selwitz, health-care analyst for Cruttenden & Co., an investment banking firm in Newport Beach. “Although they have very good and capable management, they usually don’t go for home runs.”

Unlike many other HMOs that experienced losses during an industry depression several years ago, PacifiCare has reported steady profits since it went public in 1985, in part because the company has done well investing its surplus cash.

In its last fiscal year ended Sept. 30, PacifiCare reported earnings of $10.9 million on revenue of $650.2 million. The company’s strong growth has continued into 1990, showing first-quarter earnings of $2.9 million, up from $1.1 million for the same quarter in fiscal 1989.

In contrast, Maxicare in the first nine months of ’89 showed a net loss of $22.3 million. However, company officials say they have managed to increase the company’s cash flow by trimming overhead and that they expect Maxicare to become profitable in 1990.

Both Maxicare and PacifiCare operate similarly in that they contract for independent physicians and hospitals to provide service to their members, unlike other HMOs that own hospitals and clinics and hire their own medical staffs.

Several industry analysts believe that the proposed merger would give PacifiCare an advantage of greater economy of scale, especially in Southern California, where they already contract with many of the same physician groups.

“Assuming that PacifiCare is not overpaying and that Maxicare has some loyal clients, it would be attractive for PacifiCare to buy out the competition,” said Rae Alperstein, a vice president and health-care analyst with Bateman Eichler in Los Angeles.

Selwitz of Cruttenden & Co. said that Maxicare, through past inefficiencies, has alienated many employers and health-care providers, who he believes would welcome a PacifiCare takeover.

“I have never been convinced that Maxicare could make it on its own in a comeback. The problem with employers and providers has been too deep,” Selwitz said.

But he also said that consumers may suffer if reduced competition triggers a premium price spiral. “The implication could be higher prices for employers” who contract for group medical insurance, he said.