Valentines Day 2017 started with conversation hearts and chocolates but ended with two break-ups in the healthcare industry. Aetna announced it would end its takeover bid of Humana after a federal judge ruled against the deal due to antitrust concerns. As part of the initial merger agreement, Aetna will have to pay Humana $1 billion in break-up fees since the deal fell through.
Meanwhile Cigna, which was being pursued by Anthem, decided that their deal was effectively dead due to the same antitrust concerns. Cigna has sued Anthem seeking a $1.85 billion break-up fee. Anthem has since sued Cigna and won a temporary restraining order blocking Cigna’s attempt to terminate the merger.
So why enter into an agreement in which you risk losing billions of dollars if the deal falls through? What happened to maximizing shareholder value?
What are break-up fees ?
Break-up fees exist to compensate the other party in a takeover agreement or merger if the deal does not go through. Investopedia explains it as follows:
A breakup fee is a common fee used in takeover agreements if the seller backs out of a deal to sell to the purchaser. A breakup fee, or termination fee, is required to compensate the prospective purchaser for the time and resources used to facilitate the deal. Breakup fees are normally 1-3% of the deal’s value.
Read more: Breakup Fee Definition | Investopedia http://www.investopedia.com/terms/b/breakup-fee.asp#ixzz4Yy9RvyKK
In the case of Aetna and Humana, the situation was a bit different as Aetna was seeking to acquire Humana; however, Aetna as the acquirer is on the hook for the $1 billion. Why does the company being acquired get a fee for not being acquired?
Aetna’s Break-up Fee
Aetna’s break-up fee was described in the excerpt from their 2015 annual report below.
Failure to complete the Proposed Acquisition could negatively impact the stock price and the future business and financial results of Aetna.
If the Proposed Acquisition is not completed for any reason, the ongoing business of Aetna may be adversely affected and, without realizing any of the benefits of having completed the Proposed Acquisition, Aetna would be subject to a number of risks, including the following:
• We may experience negative reactions from the financial markets, including negative impacts on our stock and bond prices, and from our customers, providers, vendors, regulators and employees;
• We may be required to pay Humana a termination fee of either $1.691 billion or $1 billion if the Merger Agreement is terminated under certain circumstances;
Turns out the break-up fee could have been as high as $1.69 billion but Aetna is lucky to get out of it for just the $1 billion. To put things into perspective, Aetna paid out $351 million in dividends in 2016. Nearly three years worth of shareholder dividends are being paid to a competitor due to a failed merger. If I were a shareholder, I would have a problem with that. Not to mention this fee is being paid to a company that remains a competitor. Yet, this kind of wasteful spending happens all the time.
Why Aetna risked $1 billion for the merger
Back in 2015 when the acquisition was announced, the company provided the following reasoning behind the merger.
Strengthens ability to lead effort to transform health care delivery to a more consumer-focused marketplace
Establishes a leading Medicare Advantage and commercial player with enhanced nationwide presence that will improve affordability, quality and convenience for consumers
Transaction projected to realize $1.25 billion in annual synergies in 2018
Adds over 14 million total members, including 3.2 million Medicare Advantage members
Maintains commitment to Louisville, KY
Projected to be accretive to operating earnings per share beginning in 2017
The company expected to realize $1.25 billion in annual synergies within 2 years. Is it worth risking $1 billion to potentially earning $1.25 billion more annual if the deal goes through? It would make sense to do the deal in that case, all other things constant. But unfortunately, the projected synergies don’t always turn out to be realized. Costs associated with integrating the businesses, laying people off, and other problems that arise often cause delays in realizing any benefits of the merger. Then within a matter of years, the combined entities are breaking up and one of them is being spun back out to the market. Viacom and CBS are currently in that category.
Management is given incentives to make these large acquisitions so they really have nothing to lose. As outlined in the 2016 proxy statement, part of Aetna CEO Mark Bertolini’s “qualitative performance” included a reference to the agreement to acquire Humana.
CFO Shawn Guertin was also credited for his “leadership in Humana acquisition”. Management reaped the rewards of the deal even before it closed.
I’m somewhat pleased to see these merger agreements fail as I don’t want to see an even more concentrated health insurance market. In fact, I am hopeful some of the ideas Trump talked about during his campaign come to fruition. Health reform, including needed changes to Obamacare, should be one our top priorities because it is one of the most costly and frustrating expenses we have to deal with in this country.
I actually try to avoid going to the doctor because of the entire process. Fill out a ton of forms, provide my insurance, pay a co-pay, get billed, receive the portion I may owe from my health insurance provider, it goes on and on. But that’s for another discussion.
As for break-up fees, it is “just part of the business”. Management is provided incentives for their “qualitative” performance to seek acquisitions on behalf of the board. Management wins either way. If the merger had gone through, some of the employees would be receiving pink slips because that is where the synergies come from. If there is any winner in this it would be Humana since they are receiving a nice $1 billion bonus. Spend it wisely.