Health Net
On March 24, 2016, the Company acquired all of the issued and outstanding shares of Health Net, a publicly traded managed care organization that delivers health care services through health plans and government-sponsored managed care plans. The transaction was valued at approximately $5,990 million, including the assumption of $703 million of outstanding debt. The acquisition allows the Company to offer a more comprehensive and scalable portfolio of solutions and provides opportunity for additional growth across the combined company's markets.
The total consideration for the acquisition was $5,287 million, consisting of Centene common shares valued at $3,038 million (based on Centene's stock price of $62.70), $2,247 million in cash, and $2 million related to the fair value adjustment to stock based compensation associated with pre-combination service. Each Health Net share was converted into 0.622 of a validly issued, fully paid, non-assessable share of Centene common stock and $28.25 in cash. In total, 48,449,444 shares of Centene common stock were issued in connection with the transaction. The cash portion of the acquisition consideration was funded through the issuance of long-term debt as further discussed in Note 7. Debt. For the three and nine months ended September 30, 2016, the Company also recognized acquisition related expenses of $10 million and $224 million, respectively, that were recorded in general and administrative expense in the Consolidated Statements of Operations.
The acquisition of Health Net has been accounted for as a business combination using the acquisition method of accounting which requires assets acquired and liabilities assumed to be recognized at fair value as of the acquisition date. The valuation of all the assets acquired and liabilities assumed has not yet been finalized. As a result, preliminary estimates have been recorded and are subject to change. Any necessary adjustments from our preliminary estimates will be finalized within one year from the date of acquisition. Measurement period adjustments will be recorded in the period in which they are determined, as if they had been completed at the acquisition date.
Since the initial allocation of purchase price, the Company made adjustments and reclassifications to the fair value of certain assets and liabilities acquired, including the premium and related receivables, medical claims liability, accrued liabilities, return of premium payable and deferred taxes, resulting in a net increase of $275 million to goodwill. The Company will continue to revise its preliminary purchase price allocation as additional information becomes available during the remainder of the measurement period. The Company's preliminary allocation of the fair value of assets acquired and liabilities assumed as of the acquisition date of March 24, 2016 is as follows ($ in millions):
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Assets Acquired and Liabilities Assumed |
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Cash and cash equivalents |
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$ |
1,401 |
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Premium and related receivables (a)
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1,258 |
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Short term investments |
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74 |
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Other current assets |
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448 |
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Long term investments |
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2,037 |
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Restricted deposits |
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30 |
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Property, software and equipment, net |
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41 |
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Intangible assets (b)
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1,500 |
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Other long term assets |
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136 |
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Total assets acquired |
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6,925 |
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Medical claims liability |
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1,453 |
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Borrowings under revolving credit facility |
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285 |
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Accounts payable and accrued expenses (c)
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2,033 |
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Return of premium payable |
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435 |
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Unearned revenue |
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130 |
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Long term deferred tax liabilities (d)
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330 |
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Long term debt (e)
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418 |
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Other long term liabilities |
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430 |
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Total liabilities assumed |
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5,514 |
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Total identifiable net assets |
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1,411 |
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Goodwill (f)
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3,876 |
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Total assets acquired and liabilities assumed |
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$ |
5,287 |
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The Company has made certain preliminary fair value adjustments based on information reviewed through September 30, 2016. Significant preliminary fair value adjustments are noted as follows:
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(a) |
The preliminary fair value of premium and related receivables approximated their historical cost, with the exception of the risk corridor receivable associated with the Health Insurance Marketplace. The fair value of the risk corridor receivable was estimated at $9 million.
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(b) |
The identifiable intangible assets acquired are to be measured at fair value as of the completion of the acquisition. The fair value of intangible assets is determined primarily using variations of the "income approach," which is based on the present value of the future after tax cash flows attributable to each identified intangible asset. Other valuation methods, including the market approach and cost approach, were also considered in estimating the fair value. The Company has estimated the preliminary fair value of intangibles to be $1.5 billion with a weighted average life of 10 years. The Company expects the identifiable intangible assets to include purchased contract rights, provider contracts, trade names and developed technology. The Company is still in the process of finalizing its intangible valuation.
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(c) |
Accounts payable and accrued expenses includes approximately $285 million related to premium deficiency reserves based on cost trends existing prior to the acquisition date. The premium deficiency reserves are primarily associated with losses in the individual commercial business, largely in California, unfavorable performance in the Arizona commercial business as well as unfavorable performance in the Medicare business primarily in Oregon and Arizona. The premium deficiency reserve for the individual PPO commercial contracts in California includes anticipated future losses in 2016 associated with substance abuse rehabilitation claims. During the third quarter, the Company lowered the premium deficiency reserve by $15 million, reflecting its revised estimate of substance abuse cost trends.
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(d) |
The preliminary deferred tax liabilities are presented net of $526 million of deferred tax assets.
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(e) |
Debt is required to be measured at fair value under the acquisition method of accounting. The fair value of Health Net's $400 million Senior Notes assumed in the acquisition was $418 million. The $18 million increase will be amortized as a reduction to interest expense over the remaining life of the debt.
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(f) |
The acquisition resulted in $3.9 billion of goodwill related primarily to buyer specific synergies expected from the acquisition and the assembled workforce of Health Net. This goodwill is not deductible for income tax purposes. The assignment of goodwill to the Company's respective segments has not been completed at this time.
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Statement of Operations
From the acquisition date through September 30, 2016, the Company's Consolidated Statements of Operations include total Health Net revenues of $3,981 million and $8,604 million for the three and nine months ended September 30, 2016, respectively. It is impracticable to determine the effect on net income resulting from the Health Net acquisition for the three and nine months ended September 30, 2016, as the Company immediately integrated Health Net into its ongoing operations.
Unaudited Pro Forma Financial Information
The unaudited pro forma total revenues for the nine months ended September 30, 2016 were $32,369 million. The following table presents supplemental pro forma information for the three and nine months ended September 30, 2015 ($ in millions, except per share data).
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Three Months Ended
September 30, 2015 |
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Nine Months Ended
September 30, 2015 |
Total revenues |
$ |
9,960 |
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$ |
28,617 |
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Net earnings attributable to Centene Corporation |
$ |
85 |
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$ |
215 |
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Diluted earnings per share |
$ |
0.49 |
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$ |
1.25 |
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The pro forma results do not reflect any anticipated synergies, efficiencies, or other cost savings of the acquisition. Accordingly, the unaudited pro forma financial information is not indicative of the results if the acquisition had been completed on January 1, 2015 and is not a projection of future results. It is impracticable for the Company to determine the pro forma earnings information for the nine months ended September 30, 2016 due to the nature of obtaining that information as the Company immediately integrated Health Net into its ongoing operations.
The unaudited pro forma financial information reflects the historical results of Centene and Health Net adjusted as if the acquisition had occurred on January 1, 2015, primarily for the following:
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Additional interest income associated with adjusting the amortized cost of Health Net's investment portfolio to fair value. |
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Elimination of historical Health Net intangible asset amortization expense and addition of amortization expense based on the current preliminary values of identifiable intangible assets. |
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Interest expense associated with financing the acquisition and amortization of the fair value adjustment to Health Net's debt. |
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Additional stock compensation expense related to the amortization of the fair value increase to Health Net rollover stock awards. |
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Increased tax expense due to the assumption that Centene would be subject to the IRS Regulation 162(m)(6) beginning in 2015. |
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Elimination of acquisition related costs. |
Restructuring Related Charges
In connection with the Health Net acquisition, the Company undertook a restructuring plan as a result of the integration of Health Net's operations into its business, resulting in a reduction in workforce beginning in 2016 and expected to continue through early 2017. The restructuring related costs are classified as general and administrative expenses in the Consolidated Statements of Operations. Changes in the restructuring liability for the nine months ended September 30, 2016 were as follows ($ in millions):
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September 30, 2016 |
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Employee Termination Costs |
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Stock Based Compensation |
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Total |
Total accrued restructuring costs as of December 31, 2015 |
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$ |
— |
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$ |
— |
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$ |
— |
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Charges incurred |
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39 |
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40 |
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79 |
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Paid/settled |
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(25 |
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(40 |
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(65 |
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Total accrued restructuring costs as of September 30, 2016 |
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$ |
14 |
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$ |
— |
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$ |
14 |
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For the three and nine months ended September 30, 2016, the Company recorded employee termination costs of $7 million and $39 million and stock based compensation of $2 million and $40 million, respectively, in the Managed Care Segment. The Company expects to record a total of approximately $50 million of employee termination costs and $44 million of stock based compensation in connection with the acquisition, the majority of which is expected to be incurred through 2016 and early 2017.
Commitments
In connection with obtaining regulatory approval of the Health Net acquisition from the California Department of Insurance and the California Department of Managed Health Care, the Company committed to certain undertakings (the Undertakings). The Undertakings included, among other items, operational commitments around premiums, dividend restrictions, minimum Risk Based Capital (RBC) levels, local offices, growth, accreditation, HEDIS scores and other quality measures, network adequacy, certifications, investments and capital expenditures. Specifically, the Company agreed to, among other things:
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invest an additional $30 million through the California Organized Investment Network over the five years following completion of the acquisition;
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build a service center in an economically distressed community in California, investing $200 million over ten years and employing at least 300 people;
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contribute $65 million to improve enrollee health outcomes ($10 million over ten years), support locally-based consumer assistance programs ($5 million over five years) and strengthen the health care delivery system ($50 million over five years), (of which, the present value of $61 million was expensed in the nine months ended September 30, 2016 and classified as general and administrative expenses in the Consolidated Statements of Operations); and
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invest $75 million of its investment portfolio in vehicles supporting California’s health care infrastructure.
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