Integration Risk for Coventry Health

Coventry Health Care, Inc. (CVH - Analyst Report) lowered sharply its operating earnings outlook for the second quarter and fiscal 2008, citing unexpectedly high costs, including higher than expected claims in its Medicare Advantage private-fee-for-service business and heavy outpatient utilization in its commercial plan observed during the current quarter so far.

With the number of acquisitions executed in recent years, we believe the company will continue to benefit from ongoing operating improvements and margin expansion. Coventry should continue to focus on lowering overhead costs in recently acquired plans, while maintaining pricing discipline in its existing business. The acquisition of First Health diversifies Coventry’s payor mix, and we believe it will deliver a national capability to Coventry and a solid platform for entering new markets.

While we believe Coventry will continue unencumbered at the smaller end of the mergers and acquisitions arena, we anticipate incrementally higher prices by vendors as attractive targets of significant scale diminish over time. Damage caused by Hurricane Katrina in the New Orleans region should continue to impact financials.

We have valued Coventry on a forward price/earnings (P/E) basis and by a comparison to similar firms in the healthcare facilities sector. We continue to regard the integration of First Health, given its size and scope, a significant integration challenge. We believe the acquisition of Concentra will enhance the company’s service offering to workers compensation plans, an area of strength for the company, and maintain our Hold recommendation at current levels. Our $34 target price is derived using a multiple of 9.3 x FY08 EPS of $3.65.

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