Centene’s pending acquisition of WellCare puts the health insurance provider on the path to investment grade status across all agencies if the targeted USD 700m of synergies are realized. But the merger is still contending with regulatory hurdles, and several macro policy and litigation risks could jeopardize the borrower’s deleveraging timeline, according to five sources following the deal.

Led by Barclays, the company is marketing a still-fluid structure consisting of USD 7bn of senior unsecured notes, split between USD 2.5bn – USD 3bn senior unsecured notes due 2027, USD 3bn – USD 3.5bn senior unsecured notes due 2029 and a USD 750m add-on to its existing 4.75% notes due 2025.

The company circulated talk for the 2027 notes earlier today at 4.5%-4.625%, with the 2029 notes talked at 4.75%-4.875%. The add-on is talked at 102.25-102.75.

The roadshow began last Friday (15 November). Books closed at 4:30pm ET for the East Coast and will close at 9am ET tomorrow for the West Coast.

In March 2019, Centene announced its intentions to acquire WellCare for USD 17.3bn. In June, the transaction was approved by stockholders at both companies. As of today, the merger has received approval from 25 states and still requires approval from New Jersey and Illinois.

“They still need approval from two states, so it’s not a done deal yet. The sooner they get the deal done, the sooner they can start integrating the two companies,” one of the sources said.

Pro forma the deal, Centene’s debt load more than doubles to USD 15.664bn from USD 7.041bn. Along with the proposed notes, the capital structure contains: a USD 1.45bn term loan due 2024, several tranches of existing notes at Centene coming due between 2022-2026 and new exchange notes.

At the beginning of November, Centene announced exchange offers at par for all outstanding WellCare notes: the USD 750m 5.375% notes due 2026 and USD 1.2bn 5.25% notes due 2025.

Pro forma consolidated leverage comes in at 3.4x, based on USD 15.664bn of pro forma total debt and USD 4.661bn of combined adjusted EBITDA. That’s higher than Centene’s standalone leverage prior to the deal of 2.1x.

Meanwhile, the deal brings liquidity to roughly USD 11.07bn through USD 9.17bn of cash and USD 1.9bn of availability on a USD 2bn revolver due 2024.

Excluding synergies, sources expect Centene to generate roughly USD 3bn of free cash flow – or 19% of total debt — in the first year of the acquisition through USD 4.661bn of adjusted EBITDA, USD 1bn of capital expenditures and USD 700m of pro forma interest expense.

IG Synergies

Centene is projecting USD 700m of total run-rate synergies, with roughly USD 500m by year two of the acquisition.

If the company follows through on the expected synergies, sources expect the company to be upgraded to investment grade across the board. So far, the company has two investment grade ratings, BBB- from S&P and BBB- from Fitch. Moody’s still rates it at Ba1, with a stable outlook.

Moody’s places the company’s debt to capital financial leverage ratio in the 54% range and expects it to decline to 41% by year-end 2020. Among other factors, the ratings agency would consider an upgrade if the company maintained a Moody’s adjusted financial leverage of 40% or below, debt-to-EBITDA below 2.2x and a further reduction in Medicaid concentration, according to a release.

Still, given an uncertain future for healthcare in the US, some sources were skeptical that Centene would be able to achieve the targeted synergies.

“The thesis of this deal is that they will achieve these synergies and until then, you have to deal with the elevated leverage,” one of the sources said. “It’s a little bit like picking up nickels in front of a steamroller – you’re not getting enough yield for the elevated leverage and the potential that these synergies never come through.”

2020 and Beyond

In particular, Centene’s and the healthcare space’s future remain uncertain leading up to, and beyond, the 2020 election, three of the sources said.

The acquisition is expected to not only solidify Centene’s position at the top in the Medicaid provider space, but also expand its coverage in the private Medicare space.

And depending on which Democratic contender is chosen as the party’s candidate, Centene’s outlook past 2020 could be drastically different, the sources said. For example, Elizabeth Warren and Bernie Sanders are strong proponents of “Medicare for All,” which would ultimately do away with private insurance.

“If either Warren or Sanders win the [presidency] and push forward this plan, Centene, like many other insurers, will be left overexposed on the private insurance front,” one of the sources said.

To Centene’s advantage, there are several candidates with proposals that leave room for private insurance rather than doing away with it altogether. But even those proposals could shrink Centene’s coverage space, impacting growth and market share opportunities going forward, the sources said.

Another major risk facing Centene is the possible repeal of the Affordable Care Act.

Centene’s individual Obamacare coverage contributes roughly one-third to its standalone EBITDA and extends to nearly 1.9m members across 20 states through government exchanges, making it the largest provider, according to company documents.

A decision in Texas v. Azar, the most recent case to challenge the Affordable Care Act, is expected any day now, according to media reports. The case is in the 5th Circuit Court of Appeals and could go to the Supreme Court. The Supreme Court’s decision would impact Centene and other insurers on top of any people that receive their health coverage from programs created under the law.

Sources expect Centene’s proposed notes to come wide to those of Baa3/BBB+ rated Humana, an IG-rated peer in the insurance space, noting that Humana is more diversified, especially in its group insurance offerings.

Humana’s Baa3/BBB+ USD 500m 3.125% senior unsecured notes due 2029 traded today at 101.493 to yield 2.943%, up from trades at par in October, according to MarketAxess.

Centene did not respond to a request for comment. Barclays declined to comment.

2019 Debtwire