Humana Inc. Case

Case #4 - Humana Inc.  

1. Why did Humana's integrated strategy fail?

Because new trends emerge in the industries and the long-term prospects of the firm’s two businesses were growing increasingly divergent. On the one hand, the long-term outlook for managed care providers like HMOs and PPOs looked extremely bright. Total enrollment increases fast, especially for Humana. On the other hand, there were some signs that high growth was placing the company under increasing financial strain. The administrative cost ratio was high and medical loss ratio was increasing, higher than most of companies in the industry. Also, the relations between Humana and its physicians had become increasingly strained. Compared to the HMO industry, the long-term outlook for the hospital industry was bleak. Hospital profits were being squeezed by rapid increases in operating costs and declines in average hospital stays. Government policy and demographic status turned to be unfavorable as well. Besides, Humana hospitals were exposed to negative media report that they were overpriced. Undesirable performance of Humana hospitals made people worry that the market would undervalue HMO because of the integrated strategy. In 1992, the P/E ratio of the (declining) hospital industry and the (growing) HMO industry was 15 and 26, respectively. The P/E ratio of Humana was 10. The fact that Humana's P/E ratio was even lower than that of the declining hospital industry suggested a more serious problem with the negative synergies brought by integrated strategy.

1. Why do you think a spinoff might add value for shareholders?

Firms restructure to remain competitive and to respond to the change forces in the economy. A spinoff might create value by improving incentives and thereby altering corporate efficiency. It can also reveal information to outside investors. In this case, the market might value the HMO division of Humana more accurately after the spinoff. Also, negative synergies between the two division can be eliminated.

1. How would you go about quantifying the value added by a spinoff.

Calculating the average of three other major companies in the industries, the P/E ratio of hospital and HMO division are 14.44 and 14.22 respectively.