PacifiCare Is 0 for 8 in Its Quest for Acquisitions : Health care: The Cypress company’s cautious approach has made it one of the most prosperous providers in the country. And it is not giving up on its buyout efforts.

Armed with data hastily gathered by their staff, executives at PacifiCare Health Systems in Cypress worked late three nights last April to outline a plan of attack for what they hoped would be a prize acquisition.

Ever since archrival Maxicare Health Plans had filed for bankruptcy about a year earlier, PacifiCare officials had watched every move of the Los Angeles health maintenance organization. Now, it appeared, Maxicare’s troubles had eased, and it was beginning to regain its footing.

Eager to make an acquisition to ensure its growth in the lucrative Southern California market, Cypress-based PacifiCare decided to strike. It had to act quickly because Maxicare’s creditors were preparing to vote on a plan to determine the company’s future.

But in what has become a familiar story for PacifiCare, it was unable to consummate the deal. When Maxicare’s creditors turned down PacifiCare’s initial cash offer, the ever-cautious company refused to go higher.

“Some people might have let their egos get involved, but we are disciplined in what we do and the acquisitions we try for. We are determined not to get emotionally involved,” said Terry Hartshorn, PacifiCare’s cool-headed chief executive.

Maxicare was the target of one of eight serious buyout attempts that PacifiCare has made during the past two years. Each time, for one reason or another, it has come out empty-handed.

Cautious, fussy and scared are terms that PacifiCare executives willingly use to explain their lack of progress on the acquisition trail.

Its mettle tested by years of stiff competition and price wars, PacifiCare has emerged as one of the most profitable and fastest-growing companies in the managed health-care industry. Continued growth is essential to any business, but particularly to HMOs, where profit margins are thin and bottom lines rely on high volume.

But PacifiCare’s traditional route to growth--marching into a new area and starting networks of health-care providers and insured members from scratch--is becoming increasingly difficult. And now it has decided to take the acquisition shortcut, mindful that this alternative road is filled with land mines that have hobbled other HMOs.

The current shakeout in the industry has put more HMOs on the block nationwide, creating lots of attractive acquisition targets for larger companies such as PacifiCare.

And the Cypress company has amassed a sizable war chest for such purposes. In November, it raised $15 million in a stock offering and, including lines of credit, it is estimated to have at least $100 million in buying power.

“We are still an available bachelor with money jingling in our pockets,” said Hartshorn, who says the company is looking to acquire not only HMOs but possibly a dental HMO, as well. He is also scouting opportunities in the field of workers’ compensation.

Today, more than ever, expansion is crucial for PacifiCare and other HMOs. “The object in this business is to get bigger,” said Mike LeConey, senior health-care analyst for Baird Patrick & Co., a New York investment banking firm.

“You get economies of scale and power from size, and it is quite clear the HMO industry is increasingly moving from a highly fragmented business to a highly concentrated one with only a few major players,” he said.

But PacifiCare will not be rushed. Hartshorn said he expects to make at least one acquisition within the next 12 months because he wants to take advantage of what he believes will be a one- or two-year “window of opportunity” in the marketplace.

Earlier this year, PacifiCare pulled out of a negotiation to buy Oakland-based HEALS Health Plan, a deal that would have given PacifiCare a foothold in Northern California. PacifiCare withdrew when it took a second look at HEALS’ financial books and discovered a large debt to physician contractors that it would have to shoulder.

“We are fussy,” Hartshorn said. In at least once instance, too fussy, he acknowledged, saying he regrets not having made a higher bid three years ago for an HMO in St. Louis that has since far outperformed his projections.

PacifiCare has been criticized for its lack of aggressiveness. But, as it turned out, the company’s conservative business policy has been the keystone of its financial success.

Industry experts who had once chided PacifiCare for lagging behind Maxicare--which quickly expanded across the country and grew into the nation’s largest publicly traded HMO--now acknowledge that, as in the proverbial race of the tortoise and the hare, PacifiCare slowly but persistently outdistanced its flashier competitor.

While Maxicare and some other HMOs got into financial trouble by making poor acquisitions and piling up heavy debts, PacifiCare grew by sticking to its rather humble goal of developing as a strong regional player in Southern California and a few other Western states.

Few HMOs in the nation are as financially sound as PacifiCare, which has never had an unprofitable quarter since it went public in 1985. By contrast, many other HMOs have suffered severe losses, or failed altogether, for lack of the kind of management savvy that has pulled PacifiCare through tough times, analysts say.

PacifiCare was “one of the few HMOs that stayed profitable in the last half of the ‘80s, when the industry was in a sea of red ink,” said Joel Menges, director of analytical services for American International Health Care Inc., a consulting firm in Rockville, Md. He noted that between 1986 and 1988, the industry as a whole lost $2 billion.

Among the reasons for PacifiCare’s achievement, observers say, is that it avoided the fierce price wars during that period that led to competitors underpricing their services.

Also, PacifiCare is one of the few companies in the nation that has successfully developed a program to provide HMO benefits to Medicare recipients. While PacifiCare’s Medicare business has grown to the point that it contributes more than half the company’s earnings, the strategy has a drawback: It leaves the company highly susceptible to changes in government policy.

In February, the company’s stock took a temporary dive when Wall Street learned that the reimbursement increase that the federal government will give HMOs with Medicare contracts next year will probably be considerably lower than anticipated. That blow is worsened by the elimination of any federal reimbursement for catastrophic benefits that Medicare fully covered for HMO enrollees this year.

PacifiCare and other HMOs are considering making up for the smaller rate increase by canceling or reducing catastrophic benefits or raising monthly fees paid by the elderly.

“Nobody knows if they will succeed in making up those gaps or if their membership growth will be stunted. So, at least temporarily, there is a cloud over the HMOs that participate in the Medicare program,” said Seth Shaw, health services analyst for the Prudential Bache investment firm.

But analysts are generally upbeat about PacifiCare’s future.

Todd Richter, senior vice president and health services analyst with the Dean Witter Reynolds brokerage in New York, praised PacifiCare as “an extremely well-managed company with an outstanding corporate philosophy. They want the HMO to be good for the investors, the doctors and the patients. As hokey as it sounds, they don’t just say it, they try to do it.”

Analysts say a peculiar strength of PacifiCare is that Hartshorn, who has headed the company since its founding in 1976, and his executive team have stayed with the company, giving it stability and experience that are missing in other HMOs.

Another plus is geography: PacifiCare is at the center of Southern California’s fast-growing job market, where HMOs, starting with Kaiser Permanente, are well-established and have met with far greater acceptance than in most other parts of the country. In California, 30% of the population is enrolled in an HMO plan, a larger percentage than in any other state.

Also, the desire of employers to control the soaring cost of medical care has increased the attractiveness of health maintenance organizations. HMOs pay physicians a monthly fee for each enrollee, with the objective of giving them an incentive to provide the most cost-effective care.

By contrast, traditional indemnity insurance plans have no rate agreement with health-care providers and reimburse a fixed percentage of medical bills.

The proof that HMOs can better hold down medical costs, PacifiCare executives say, is that while indemnity insurance carriers are raising their premium rates by 30% to 40% a year, PacifiCare’s rates are rising in the range of just 12% to 15%. This kind of performance has enabled PacifiCare, which has HMO organizations in California, Oklahoma, Oregon, Washington and Texas, to increase its plan enrollment more than six-fold--to 670,000 persons from 110,662 in September, 1985.

PacifiCare’s financial growth has been equally explosive. Between fiscal years 1985 and 1989, revenue soared from $88 million to $650 million. Earnings haven’t kept pace, however, growing from $5.7 million to $10.8 million during that period.

In the first half of its current fiscal year, PacifiCare’s earnings rose to $6.9 million, more than double the $3.2 million it earned during the year-earlier period. Revenue jumped to $451.2 million from $280 million.

The company’s mainstay, PacifiCare of California, is the sixth-largest and third-fastest-growing HMO in the nation, according to a survey by InterStudy, a nonprofit health research firm in Minnesota. It also ranks among the top 2% of the nation’s HMOs in profitability, according to a survey by American International Health Care. Its net earnings of $14.4 million last year helped it offset losses from newer plans in Texas and Oklahoma.

Because of numerous factors--ranging from greater competition to tougher state requirements for emergency reserves--the process of founding new HMOs is becoming increasingly lengthy and financially burdensome.

Hartshorn points out that PacifiCare broke even in California in 1981 after a three-year effort that cost $2.2 million. By contrast, he said, PacifiCare has spent about $7 million to enter the Texas market and after five years is just approaching profitability.

Besides, the market for HMO acquisitions has never been better. Since January, 1988, the number of HMOs in the country has declined to 575 from 653, and industry consolidation is expected to continue as more small HMOs fold or seek partners.

The advantage of greater size in the HMO industry starts with the lessening of financial risk from medical catastrophes. In the winter of 1986, PacifiCare was suddenly hit by an unusually large number of expensive premature births that nearly erased its profit in the January-through-March quarter of 1986. That wouldn’t happen today, Hartshorn said, because the cost could be spread over a larger revenue base.

Another advantage of size is that it gives an HMO more clout in bargaining with doctors and hospitals for reduced rates.

But PacifiCare is not about to expand at any price. The company’s conservatism now wins kudos from many industry observers. “The fact they have turned down opportunities is probably another indication of their savvy. In my opinion, there is too much money being paid for a lot of these struggling HMOs,” said Menges of American International Health Care.

Hartshorn recollects, however, that there was a time when industry experts applauded Maxicare and other HMOs for boldly building networks to span the nation and paid little attention to PacifiCare’s growth in Southern California. “They (Maxicare) had more sizzle, more pizazz, and we were plodding along,” he said.

PacifiCare officials say probably the most important decision the company made was to contract with Medicare. They say it has been a challenge for the company to learn how to provide the greater amount of medical and personal attention that the elderly demand and still make a profit within the budget allocated by the federal government.

Other HMOs have withdrawn from the Medicare business after getting burned. More have simply stayed away. “There is no question many HMOs would still say it is too risky to get into,” said Alan Hoops, PacifiCare’s chief operating officer.

But, so far, PacifiCare’s Medicare business has paid off handsomely. With an enrollment of 117,700 seniors, Secure Horizons represents only 18% of PacifiCare’s membership but generates 45% of the company’s annual revenue and more than half its earnings.

While the profitability of its Medicare business is expected to suffer to at least some degree next year because of the change in federal payment policies, Hartshorn said, “it is still part of the market we are commited to as a company.”

If persistence remains a PacifiCare trait, so does conservatism. Even as Hartshorn talks about constructing a new “campus” of buildings to house the 1,000 workers at PacifiCare’s headquarters--a number that has doubled in a year--he insists that the company is not geared to flashy plays and overnight success.

“We tell our shareholders we aren’t a home-run hitter. But we are a more consistent performer over a period of time,” Hartshorn said. “Our goal is to provide a 20% to 30% increase in earnings every year, with a 20% plus return on equity. And for the last three years, we have been able to do that.”