The Depth Report - Anthem and the Double Black Swan
During the first few weeks in February, we had an interesting debate with a friend on the topic of Anthem, Inc. (ticker: ANTM), the giant health insurance company. Our friend does high-quality research, and is a great stock-picker. We’ve debated stocks for years, and while we usually come to a resolution, we were unable to do so regarding Anthem. Our friend was buying the stock last week. We advised avoiding it.
The Case for Anthem
Anthem is a high-quality company in a great business. The health insurance companies have been growing for years, and Anthem is both large and well-run. Many people think of insurance companies as the institutions which try to deny as many claims as they can. In reality, over the long-term, they want to cover as many medical issues/expenses as possible. These companies make a margin on overall healthcare spending so the more expensive everything is and the more healthcare people are using, the higher profits will be. The long-term trend in the United States has been very favorable, and the industry has consolidated to the point that there are only 4 large providers.
The industry also has a built-in barrier to entry due to a local-market information advantage. A well-capitalized company could decide to enter specific markets with a new health insurance product, but without access to an enormous amount of data about the healthcare spending of that population, it’s difficult to price the product appropriately. In addition, a large provider in a market already has relationships with thousands of healthcare providers and has negotiated volume discounts. While it’s possible to enter a new market, the overall trend in the health insurance industry has been towards less competition rather than more.
Our friend pointed out that Anthem is growing about 15% a year. With the stock then at $300, it was trading at 13.5x this year’s earnings. In general, the opportunity to buy a high-quality company with years of growth ahead of it at a discount multiple is a good way to make money and was the basis of our friend’s sound thesis.
Why We Disagreed:
We agree with every point above, and still argued for avoiding Anthem. The company is in the unusual position of facing two potential disastrous events. The first is a political risk. When we started discussing Anthem, almost every candidate in the Democratic primaries had come out in favor of government-run health care, and both Bernie Sanders and Elizabeth Warren had made it clear that their goal was to eliminate health insurance companies entirely. As of this writing, the Sanders campaign is surging, and the Warren campaign is fading. While Americans have debated the proper amount of government involvement in the healthcare field for decades, it’s unusual for Presidential front-runners to talk about a total government takeover, and the elimination of the entire health insurance industry. We had to consider the non-zero probability that these companies could actually be worth zero.
Our friend responded with two arguments. His first was that President Trump was likely to win re-election. We agree on that point, but note that between now and November, there’s a lot that can happen. His second point was that in the event of a Sanders Presidency, he still wouldn’t be able to push a total takeover of American healthcare past Republicans in the Senate. That’s where we disagree.
For Sanders to win in November would require an extraordinary event like a second impeachment, a scandal, or an economic collapse caused by a global pandemic. Some of these events are more likely than others, but should any of them happen, a Sanders win would likely be accompanied by a Democratic wave election where the party kept control of the House and took control of the Senate. Remember that the Senators up for election this year were elected in 2014, a big Republican wave election. Republicans are defending 22 seats while Democrats are only defending 12 seats. In the event of a Sanders win, Democrats only need to turn 3 of those seats to take control of the Senate.
At that point, Republicans could still filibuster legislation, and here’s where we engage in a little bit of speculation. Harry Reid weakened the filibuster for judicial nominations, and Mitch McConnell returned the favor by weakening it further for Supreme Court nominations. We note that a government takeover of the healthcare system has been a Democratic legislative priority for a long time, and that once they accomplish it, Americans will never move to eliminate it. In that scenario, we believe a hypothetical Majority Leader Schumer would eliminate the filibuster to pass legislation that would grant Congress control of the healthcare system. While the above isn’t likely, it’s also not a one-in-a-thousand shot either.
The second reason we argued for avoiding Anthem is the current corona virus outbreak. The virus is spreading in non-Asian countries, and the US just flew a plane full of people who had been exposed back home last week. Our friend pointed out that other than gold stocks, and pharmaceutical companies there were very few safe havens in the event of a widespread outbreak.
We agreed, but noted that in the event of a US outbreak, Anthem is one of the companies that will be footing the bill for extended hospitalizations. It looks like a positive corona virus test accompanied by symptoms could easily result in a two-week hospital stay. The cost of that would depend on what procedures were done, but we wouldn’t be surprised to see a six-figure bill for a lengthy hospital stay especially when it would have to be in an isolated room. It’s one thing to have exposure to a slowdown in business activity caused by a virus. It’s another thing entirely to have to underwrite the medical cost of a viral pandemic.
As noted above, our friend is a smart stock-picker with a good thesis on a great company. Our issue is we see two black swan scenarios that could make the stock worth $0. That’s more risk than we’re comfortable with given the current situation.