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State’s Crowded Market Depresses HMO Shares : * Health Care: California facilities find it difficult to raise prices because of stiff competition, a Merrill Lynch report says.

TIMES STAFF WRITER

Share prices of PacifiCare Health Systems and other health maintenance organizations dropped Friday as New York analysts voiced concerns about increased competition in the California market. But other observers said long-term prospects for the HMOs still look robust.

HMOs, which charge patients a fixed monthly fee to provide health care through their own clinics or networks of physicians, have shown solid earnings growth in recent years as employers eager to control health-care costs urge their workers into the networks and away from traditional indemnity insurance plans.

But a Merrill Lynch report released Friday argued that HMOs in California are facing difficulty in raising prices because of a crowded market, and that enrollment growth is slowing as market penetration is rising.

Earlier this week an article in Barron’s also dampened investor enthusiasm by pointing out growing disenchantment with HMOs and noting that as subscribers demand more flexible services, HMOs are having trouble containing costs.

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Prices of PacifiCare shares closed at $32.25, down $3.50, and FHP dropped $3.75 to close at $20.50 in trading on the over-the-counter market. In American Stock Exchange trading, Foundation Health Corp. shares fell $3.125 to close at $23.875. Other HMOs, including Blue Bell, Pa.-based U.S. Healthcare and United HealthCare of Minnetonka, Minn., also closed down.

The selloffs followed strong run-ups in the price of many HMO stocks over the past year, and analysts said Merrill Lynch’s downgrading may reflect over-inflated expectations for HMOs, which have consistently outperformed predictions in recent years. Despite strong second-quarter results, they may have been less spectacular than some investors hoped, analysts said.

Lucy Olwell and Jean Queally, analysts at Merrill Lynch in New York, said in their report that large California employers are encouraging HMOs to provide services statewide.

As a result, Cypress-based PacifiCare and Fountain Valley-based FHP International are taking on increased costs to expand in Northern California.

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They noted that new HMO enrollment is slowing since penetration is already higher in California than almost any state, with 35% of Southern Californians and 40% of Northern Californians already signed up. But other analysts argued that the future looks bright for HMOs. “They are the only rational, cost-effective way of delivering health care,” said Kenneth Abramowitz, an analyst at Sanford C. Bernstein.

HMOs have limited cost growth to 10% a year, compared to 20% a year by indemnity insurers, according to Abramowitz. “HMOs are cash-generating machines,” said Mark Matheson, an analyst at Cruttenden & Co. He noted that PacifiCare’s cash balance had increased from $160 million last September to $179 million today, a large proportion of total assets of $282 million.

He argued that because of strong earnings potential, the company could be “an attractive acquisition target” by large health insurance firms seeking to expand in the California HMO market.

HMO Stocks Sink

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Shares of major health-maintenance organizations tumbled Friday after Merrill Lynch analysts expressed worries about rising competition.

Fri. close Pct. 52-week Stock and change drop high/low Sierra Health 18 7/8, -3 1/2 -15.6% 29 1/2-5 1/2 FHP International 20 1/2, -3 3/4 -15.5% 29 3/4-8 3/4 Foundation Health 23 7/8, -3 1/8 -11.6% 35-9 7/8 PacifiCare 32 1/4, -3 1/2 -9.8% 42 1/2-12 Maxicare Health 8 3/4, - 3/4 -7.9% 9 3/4-7 U.S. HealthCare 29 1/4, -1 3/4 -5.7% 38-10 United Healthcare 48 1/2, -2 3/4 -5.4% 54 5/8-13 1/8

All stocks traded on NASDAQ except Foundation and Sierra (Amex)


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