How activist investor Politan Capital can increase profitability at Centene

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Company: Centene Corp. (CNC)

Companies: Centene is a multinational healthcare company providing programs and services to the under and uninsured in the United States. The Managed Care segment provides health coverage to individuals through government-subsidized programs, including Medicaid, government child health insurance programs, long-term services and support, foster care, and Medicare-Medicaid plans. The Specialty Services segment offers services for the administration of pharmacy services; Nurse advice line and after-hours support services; and visual, dental and human resources services for correctional facilities and other government agencies; and services to beneficiaries of the Military Health System. This segment offers its services and products to government programs, correctional facilities, health organizations, employers’ associations, and other commercial organizations.

Market value: $ 44.2 billion ($ 75.86 per share)

Activist: Politan Capital Management

Percentage ownership: ~ 2.0%

Average cost: n / A

Comment from the activists: Politan Capital Management was founded by Quentin Koffey. Most recently, Koffey led the Senator Investment Group’s activism strategy. Prior to that, he led the activist practice at DE Shaw and prior to that he was with Elliott Associates. Koffey runs Politan more like a private equity fund than a traditional long-short equity hedge fund in that it can draw on committed capital to give it enough time to achieve its goals through active engagement with board members and management teams to improve Governance and operations to achieve or strategic direction. Politan looks for (i) high quality companies that are below their competitors or their potential, (ii) where there is a clear solution, and (iii) a clear path to implement that solution.

What’s happening?

On November 3, 2021, the Wall Street Journal reported that Politan Capital had acquired a stake in Centene.

Backstage:

Centene is a managed care organization that provides health insurance coverage to individuals through government subsidized and commercial programs. Centene is state-hired and works to improve the quality of care for Medicaid recipients and other government programs. The company receives a contractually agreed premium per member and bears the medical costs. This is recalculated annually. Centene offers its services to many countries, which in turn also work with Centenes colleagues. This results in a very stable, predictable flow of sales for Centene. Additionally, the states are working with Centene and his colleagues to achieve actuarially solid margins that will prevent these companies from making or losing a profit on their services.

This is a very low margin business, with net profit margins of 2% to 4%. If 2 percentage points of margin is the difference between doubling your bottom line or not, these companies’ valuation largely depends on how the costs are managed. In this regard, Centene has clearly lagged its peers with a profit margin of 2.4% versus WellCare (which Centene recently acquired) at 4.2% and Molina Healthcare at 4.5%. One of the reasons Centenes’ margins lag behind those of its peers is because the company has grown primarily through acquisitions, most recently acquiring WellCare for a $ 19.6 billion transaction. These acquisitions need to be integrated and operations centralized.

Fortunately, there is a clear roadmap to success here because that is exactly what the management of WellCare and Molina have done to increase their margins. But that process has to start with the board, and this is where Koffey’s activist expertise comes in. In the past, he has worked as a board candidate with seasoned industry leaders (e.g., CoreLogic – Bill Foley, Lowe’s – David Batchelder) and has enlisted Kenneth Burdick and Wayne DeVeydt in this situation. Burdick is the former WellCare CEO who oversaw the margin improvement, and DeVeydt is the former CFO of Anthem Inc. They are obvious choices to get on the board and with five seats on the company’s board we expect two this year further and probably different nominees.

This is a board in desperate need of a refresher – the average tenure on the current board is 11 years and the average age of the directors is 70 (both would be higher but for the new directors only added due to the WellCare merger). More than half of the board of directors have been in office for over 15 years (versus 1% of all S&P 500 directors). The company’s CEO is 78 years old and has been on the board for 25 years. The lead director is 87 years old, also served on the board for 25 years, and was the lead director the entire time (compared to an average lead director tenure of four years at S&P 500 companies). For the first time since going public, the company needs a board of directors and fresh eyes to hold management accountable and develop a comprehensive succession plan.

Politan’s style is to work amicably and calmly with management to achieve its goals. They don’t send angry public letters or seek proxy fights. However, they will not shy away from a proxy fight if their hand is forced: Koffey has shown this at CoreLogic and Hess. Politan will likely stand up for Burdick and DeVeydt as directors. In the end, they’ll be more focused on how skilled and dedicated the directors are – and less on where they’re from. This is a situation that should calm down, but when it comes to a proxy battle we expect Politan to win. A new board of directors holding the right management team accountable can mimic what Burdick did at WellCare, and a 4.5% margin could trip the company’s share price.

Ken Squire is the founder and president of 13D Monitor, an institutional shareholder activism research service, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of 13D activist investments.

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