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On Tuesday, UnitedHealthcare, a division of UnitedHealth Group (UNH - Free Report) , announced its plan to acquire XLHealth Corp, a sponsor of Medicare Advantage health plans. With this acquisition, the company is expected to remain a step ahead of its competitors including WellPoint Inc. and Aetna Inc. (AET - Free Report) in acquiring Medicare Advantage (MA) business.

Also, as the MA business is expected to grow considerably over the next five years, the latest acquisition will be a big advantage for the company to strengthen its financials.

The all-cash deal, which is valued at approximately $2 billion, is expected to close in the first half of 2012. Immediately after the closure, the deal will be accretive to UnitedHealth Group’s earnings. UnitedHealth currently enjoys the leading position in the MA market with 18.4% market share, followed by Humana Inc. (HUM - Free Report) with 16.1% market share. The deal is expected to further strengthen its position in the MA market.

We have been witnessing increasing thrust in the MA space, for quite some time. An MA plan is a government program, but is offered by commercial insurers to the Medicare beneficiaries.

The first baby boomers will hit their retirement age soon and will opt for managed care plans. Health Insurers are thus looking to acquire providers of managed care plans to the seniors which in turn will help them generate higher revenues. Also, managed-care plans for Medicare is expected to generate incremental revenue of $10 billion by 2015, which would make such acquisitions valuable.

Carriers in the health insurance sector are in a race to win MA market share and the fastest way of doing this is to plan for such acquisitions. An overview of the recent deals will provide us some idea on the pace of M&A activity in this arena.

In late October, CIGNA Corp. (CI - Free Report) announced its intention to acquire HealthSpring Inc. for $3.8 billion. HealthSpring has a niche presence in the MA market. Following the closure of the deal, CIGNA’s current rank of 52 (with market share of 0.3%) in the MA market would jump to rank 6 (market share of 3%), thereby, enhancing its presence in the MA market as compared to its peers.

Similarly, Humana struck two deals for small Medicare Advantage plans during the third quarter 2011. In August, it announced an agreement to acquire Arcadian Management Services. Later in September, it signed a deal for MD Care. Both deals are expected to close before the year-end and enhance Humana’s MA membership by 4.1%, upon completion. 

On October 1, Aetna closed on its acquisition of Genworth’s Medigap business for $290 million. 

Also, during the first half of the year, Brentwood-based Inspiris, which provides care and care management services to elderly patients in Medicare, Medicaid and commercial insurance populations, was acquired by UnitedHealth, while CareMore Health Group was purchased by WellPoint. Thus, we can clearly conclude that Medicare Advantage has been an attractive area for consolidation recently.

Coming back, UnitedHealth ended the third quarter with cash and cash equivalents of $13.7 billion, almost a 50% increase over 2010 level. The company’s cash from operation increased 53% year over year to $7.4 billion. Going forward, we expect the company’s strong cash position to help it pursue further acquisitions.

UnitedHealth currently retains a Zacks # 3 Rank, which translates into a short-term Hold rating. However, considering its fundamentals, we are maintaining our long-term Outperform recommendation on the shares. 

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