Analyst Questions PacifiCare’s Ability to Project Earnings
Two earnings bombs in nine months have led one Wall Street analyst to question whether Santa Ana-based PacifiCare Health Systems Inc. is able to give a clear picture of how its business is doing.
“The company seems to be unable to give the investment community any reliable prediction of its earnings,” said David Shove, a Prudential Securities Inc. senior managed care analyst. PacifiCare’s new management team “doesn’t seem to have enough humility to recognize when their information is suspect,” Shove said.
Late last month, PacifiCare revised its profit estimates for the year down sharply, from the $2.94 a share offered in February to $1.65 to $1.75 a share. The move followed a PacifiCare warning in October for the third quarter. At that time, company officials warned that higher medical costs would chew up profits into 2001.
Then, in April, PacifiCare surprised Wall Street again by easily beating lowered fourth-quarter estimates.
PacifiCare said it believes Prudential’s Shove is “in the minority,” according to Suzanne Shirley, the company’s vice president of investor relations. “(Shove) doesn’t believe our numbers are reliable. We believe they are reliable. I guess we just agree to disagree.”
The company is “very diligent” before revising earnings estimates, she said.
Wall Street “was certainly skeptical of our original (February) guidance. They’re more comfortable with this. This is not something we take lightly,” Shirley said.
But Shove wrote in a recent research report that the input he’s getting from PacifiCare has caused him to doubt his own projections.
“Our confidence in our own estimates is low,” he wrote.” We do not expect credible earnings visibility to return for at least 12 months.”
Shove recently downgraded PacifiCare from “hold” to “sell,” a move he said wasn’t driven by the recent earnings warning but rather the state of managed care.
Among the troubles, according to Shove: PacifiCare’s commercial, or non-Medicare, business is under-priced even after a recent rate increase. And the company’s information systems need improvement to get better claims data, he said.
Still, Shove stopped short of directly laying all the blame at the current management team’s feet. In October, Howard Phanstiel stepped in as interim chief executive to replace Robert O’Leary, who resigned. PacifiCare’s board affirmed Phanstiel as the company’s chief executive in December.
“They began working (with a situation) that was at best in bad shape and at worst in terrible shape,” Shove said of Phanstiel and the new management. “If I were an investor and I was assigning blame, I’m not sure that I’d assign it directly to the management team.”
In its recent earnings warning, PacifiCare cited higher medical costs in California, which is about 60% of its market.
Specifically, “it became evident that the commercial (medical-cost ratio) in California, while trending downward over the course of the year, would exceed previous expectations on a full-year basis,” Phanstiel said in a statement.
“The improved performance being achieved by our other health plans and our specialty companies will not be sufficient to offset this trend, which will slow our progress toward improved margins in California,” Phanstiel said.
PacifiCare’s had to deal with increasing demands from its hospitals and physicians for shared-risk arrangements instead of fixed-payment plans. The company still has many fixed-payment, or capitated, contracts. But complaints from providers led it to jump deeper into the shared-risk market, where the company agrees to pay more as providers’ costs rise.
Some analysts are taking a more measured view of PacifiCare’s problems. Goldman, Sachs & Co.’s Charles Boorady wrote in a research note that PacifiCare’s warning was consistent with his own estimate revision in early May. Boorady lowered his 2001 earnings estimate for PacifiCare to $1.65 from $2.20. Goldman Sachs owns more than 860,800 shares of PacifiCare, a stake valued at around $15 million as of last week.
According to Boorady, problems at PacifiCare could benefit rivals such as WellPoint Health Networks Inc. and Health Net Inc., both of Thousand Oaks, “as (PacifiCare) will have to raise its prices and members switch health plans.”
PacifiCare has said it would raise premium prices by 15% to 19% on about a fifth of its business, with contract renewal dates of July 1 and Oct. 1.
Company officials are hoping that they can boost profitability with price increases on their commercial and Secure Horizons Medicare HMO business. Medicare accounts for around 60% of PacifiCare’s profits and revenue, but officials have been searching for ways to reduce the company’s dependence on the business.
Medicare is a big concern for PacifiCare investors. Goldman Sachs’ Boorady, in his report, said PacifiCare received some relief from recent premium hikes, “but not nearly enough to get us comfortable. (PacifiCare’s) exposure to Medicare, at about 57% to 58% of premium revenues, is much higher than most of its competitors.”
Prudential’s Shove said PacifiCare’s Medicare business isn’t necessarily what worries him.
“Medicare is not necessarily a bad idea,” Shove said, noting that the U.S. Health Care Financing Administration has shown interest in revitalizing Medicare Plus Choice, which uses HMOs as a linchpin for care delivery. n
