S&P Revises Outlook on WellPoint

Standard & Poor’s has revised its outlook on WellPoint Inc. (NYSE:WLP; WellPoint; formerly Anthem Inc., renamed following merger with WellPoint Health Networks Inc.) to stable from positive.

At the same time, Standard & Poor’s affirmed its ‘BBB+’ counterparty credit and senior debt ratings on WellPoint.

In addition, Standard & Poor’s affirmed its counterparty credit and financial strength ratings on WellPoint’s operating subsidiaries.

At the same time, Standard & Poor’s lowered its counterparty credit and senior debt ratings on WellPoint Health Networks Inc. (now an intermediary holding company retaining $800 million of senior long-term debt) to ‘BBB+’ from ‘A-‘ and removed them from CreditWatch, where they were placed on Oct. 27, 2003, following the announcement of the merger. The outlook is stable.

The outlook revision reflects the completed transaction, which is valued at $16.5 billion. WellPoint will finance $2.8 billion in bridge and revolving credit facilities to help pay for the cash portion of the largely stock transaction. The state-specific pledges made for California and Georgia are not material to the overall cost of the transaction.

The merger will increase intangibles by $11 billion, effectively reducing the quality of capital at the new holding company. The combined entity is expected to rebuild the quality of its capital over time through debt repayment and retained earnings; however, there is uncertainty about the timeframe over which this will be restored. As a result, Standard & Poor’s has widened the ratings gap between parent holding company and insurance operations to three notches. Previously, for both companies, there was only a two-notch gap because of geographic diversity and the multiple sources of parent-company cash, which reduce credit risk for the parent company.

Both companies are generating extremely strong operating performance and cash flows. Standard & Poor’s believes their integration plans can be executed and expects an enhanced business position for the combined entity. The combined company would have nearly 28 million members and pro forma revenues of more than $40 billion, making it the largest managed care company in the country. The combined company will operate as the Blue Cross or Blue Cross and Blue Shield in 13 states. Its earnings are very well diversified geographically and by legal entity, with some diversity added through specialty businesses.

Although the combined company’s geographic diversity minimizes its risk to any one regulatory body, the company is not immune to the recent scrutiny that some companies have been facing from regulators. On a pro forma basis for 2003, the combined company would have generated pretax earnings of about $2.4 billion. The pro forma capital adequacy ratio of the combined entity is very strong at about 173% as of Dec. 31, 2003.

Although both companies are experienced and skilled in integrating the operations of acquired companies, this merger is not without risk. The transaction will be the largest integration project for both and presents greater potential for cultural issues.

Given the degree of intangibles and the magnitude of the integration challenges, the outlook revision and ratings actions assume that additional near-term acquisition activity will be minimal.