Column: How Aetna frittered away $1.8 billion on a merger destined to fail
Breakups are always emotional, more so when they’re expensive. Let’s calculate the financial carnage of Aetna’s breakup with Humana, a $34-billion merger deal that was shut down by a federal judge three weeks ago and ended by the two big insurance companies on Tuesday.
We figure that Aetna wasted roughly $1.8 billion, pre-tax, in pursuit of a merger that many experts said was so anti-competitive that it probably wouldn’t fly. This is a good portion of Aetna’s $2.3 billion in reported profit last year, on revenue of $63.2 billion. Of course, the costs are generally tax-deductible, so the U.S. taxpayer effectively is footing at least part of the bill — perhaps one-third, based on standard corporate tax rates.
Given that Aetna is a company that whined piteously about much smaller losses on its Affordable Care Act business — so much so that it cut loose more than 700,000 individual insurance customers to save money — it’s proper to ask what they were thinking.
We know what they say they were thinking: Aetna Chairman and Chief Executive Mark Bertolini mouthed the boilerplated platitudes in the announcement of the breakup. “We continue to believe that a combined company would create greater value for healthcare consumers through improved affordability and quality,” he said.
An expensive and risky bet on an uncertain outcome... with consequences that could limit competition and have a negative impact on consumer choice.
Sen. Elizabeth Warren, et al, on Aetna’s $1-billion merger breakup fee
This is the usual unspecific pap employed to justify any big merger, especially in healthcare. If we’ve learned anything from experience, it’s that such mergers end up raising prices and reducing efficiencies and innovation. In other words, the opposite of what Bertolini claimed. That’s because lower prices and greater efficiencies and innovation stem from competition, which is exactly what mergers like the Aetna-Humana deal destroy.
The sophistry that surrounded the deal didn’t stop there. Last August, Aetna withdrew from 11 of the 15 states where it was offering individual insurance plans under the Affordable Care Act. The company claimed this was a business decision based on mounting losses in the market. But U.S. Judge John D. Bates, in his decision blocking the merger, called that deceitful: Aetna dropped much of that business, he found, to improve its litigation position in the government lawsuit over the merger.
Bertolini also had asserted in public that Aetna’s discussions with the government about the merger and about its participation in the ACA exchanges were “separate conversations.” Internal company documents revealed that Aetna had explicitly tied them together, telling the Justice Department that if it tried to block the merger it would pull out of the exchanges. The department sued to block the merger, and Aetna made good on its threat.
Now that the merger deal is dead, let’s turn to the cost of the funeral.
Technically speaking, the Aetna arrangement is a “reverse termination fee” owed by the buyer to the seller. These have become more common on deals that are vulnerable to regulatory challenge. The goal, according to Afra Afsharipour, a law professor at UC Davis whose specialties include mergers and acquisitions, is to compensate the target for the disruption that results from a blocked merger.
Aetna’s is at the low end of the range of such fees, coming to about 2.9% of the value of the transaction. Typically they’re closer to 4%. Anthem, for example, will have to pay Cigna a $1.85-billion fee, or 3.4%, for its failed $54-billion merger, which was also blocked by a judge and called off by Cigna on Tuesday.
What’s problematic about the Aetna case, Afsharipour adds, is that Aetna cited the breakup fee as a reason for the Justice Department to approve the merger, placing it among the costs it would incur if the agency sued. “Their argument was, ‘If you don’t allow the deal, we’ll have to pay $1 billion,’” she observed. “But they’re the ones who agreed to the fee.”
Sen. Elizabeth Warren (D-Mass.) and four Democratic colleagues made this very point in a September letter to Bertolini, in which they noted that the companies had ample warning that their merger would invite a stiff regulatory challenge. They called the breakup fee “an expensive and risky bet on a highly uncertain outcome… with consequences that could limit competition in the marketplace and have a negative impact on consumer choice.” They asked, “When Aetna agreed to pay this fee, was Aetna aware that it would endanger participation in the ACA exchanges?” It isn’t clear if they ever got an answer.
There’s more to the cost of the failed merger. In June, Aetna floated $13 billion in bonds to fund the merger. It was the third-largest bond deal of the year up to that point, at interest rates ranging from 1.9% to 4.375% a year. The bond issuance cost Aetna $82.5 million in commissions and fees, according to the bond prospectus. On Tuesday, the company said it would buy back all the bonds at 101% of their face value, with the 1% premium costing $130 million. The company also owes interest from June to mid-March, when the repurchase will be done, which we figure will come to about $304 million. Total bond expenses: more than $500 million. Aetna said it would cover the redemptions out of a $500-million note issue floated last June.
Finally, there are the transaction costs — lawyers, accountants and other money crunchers. Aetna reported “transaction and integration-related costs” of $517 million last year and $258 million in 2015, which it attributed jointly to the Humana deal and its acquisitions of Coventry Health Care and Bswift, a retail technology company. But the $6.9-billion Coventry deal closed in 2013 and the $400-million bswift acquisition in 2014, so most of the $775 million in transaction costs in 2015 and 2016 was likely due to Humana. Let’s conservatively add another $400 million to the invoice.
That brings the total cost of the Humana deal to more than $1.8 billion. And all for nothing. Compare that to the $450 million Aetna said it incurred in pre-tax operating losses on the Obamacare exchanges in 2016. Those losses, the company maintains, are prompting it to reduce its ACA customer base from 965,000 at the end of last year to 240,000 or fewer. That’s a big consequence.
But the $1.8 billion wasted on a CEO’s adventure — that’s just the cost of doing business. Bertolini’s gloss on the whole sorry episode, according to his company’s statement, is: “Both companies need to move forward.” Aetna will do so, considerably poorer.
1:55 p.m.: This post has been updated to reflect that the Cigna-Anthem merger also has been called off.
2:42 p.m.: This post and its headline have been updated to reflect additional estimates of Aetna’s costs.