There is intelligent speculation as there is intelligent investing.

April 14, 2009
Wellcare Group – An Intelligent Speculation?

Filed under: From the co-founders — Tags: Marcelo Lima, WCG, Wellcare Group — Jane Scottsdale @ 1:11 pm

Common stock investing is inherently risky, and those risks cannot be divorced from the rewards that come with them. Often, it isn’t easy to separate the speculative from the investment component of a common stock commitment. On this topic, Ben Graham, author of the classic The Intelligent Investor, has written most clearly:

Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook. More than that, some speculation is necessary and unavoidable, for in many common-stock situations there are substantial possibilities of both profit and loss, and the risks therein must be assumed by someone. There is intelligent speculation as there is intelligent investing. But there are many ways in which speculation may be unintelligent. Of these the foremost are:
(1) speculating when you think you are investing;
(2) speculating seriously instead of as a pastime, when you lack proper knowledge and skill for it; and
(3) risking more money in speculation than you can afford to lose.


With that caveat, here’s Wellcare Group (WCG), a stock that has a reasonable chance of going higher once its legal problems are resolved and its earnings normalized. As such, it may present an intelligent speculation.

First, a quick background. Wellcare is a healthcare management organization focused on Medicare and Medicaid, government-run entitlement programs for the elderly and low-income population. It has over 2.5 million members enrolled in its programs nationwide, with a large portion of them in Florida.

Its stock hovered around $120 per share when in October 2007 about 200 FBI agents raided its Tampa campus. The stock collapsed to $40, wiping out $3.3bn in shareholder value. The uncertainty was large; there was no official word of what the FBI raid was for, although newspaper reports stated that one of Wellcare’s subsidiaries had overbilled the government by $35m. In this context, the share price collapse was wildly overdone.

A quick resolution of the problem didn’t happen. Instead, the company went “dark,” not filing its quarterly and yearly financial statements and risking stock exchange delisting for its non-compliance. Periodic SEC filings kept shareholders apprised of the slow progress, but it wasn’t until early 2009 that things became clearer. The company finally filed all of its late financial statements and set a shareholder’s meeting – the first since the FBI raid – for July 30.

Wellcare is well capitalized. As of 12/31/2008, it had about $1.2 billion in cash and $153 million in debt. This debt proved to be another Achilles heel for the stock. When the company reported in 2008 that it was in technical default for not having filed its financial statements, the price dropped precipitously yet again. Fairholme Capital, which owns nearly 20% of the stock, bought a majority of the debt, likely in a move to protect its equity investment.

Throughout this misadventure, the stock has swung wildly, hitting a low of $6.12 in November and $6.23 in March of this year. Yet Wellcare’s core business remains sound, generating substantial free cash flows. The exact number for 2008 involves reversing a goodwill write-down and removing a non-recurring $103m in litigation expenses, but a normalized estimate of $4 in free cash flow per share is probably on the conservative side. While there is significant regulatory uncertainty surrounding its Medicare and Medicaid businesses, at the current price of around $13.80, it’s hard to find a way to lose.

Yet all of these uncertainties – particularly those surrounding the FBI investigation – are still large, which is where the speculative component of this investment comes in. There might be a probability of the government’s penalties being larger than expected. The company is also facing various lawsuits related to its illegal activities, including a class-action lawsuit. Defending against these will cost management’s time and shareholders’ cash.

On the other hand, Wellcare may soon begin conducting conference calls with shareholders and analysts, may soon settle with the government by paying a fine, and may ultimately get sold to a larger competitor, such as UnitedHealth Group. After it fired its disgraced former management, the board brought in Charles Berg, formerly a UnitedHealth executive, Oxford Health Plans CEO and “deal guy.”

With these factors in mind, and taking into account Graham’s three points above, Wellcare may seem like an intelligent speculation after all.

Marcelo P. Lima is a securities analyst. He may be reached at MPL4@cornell.edu

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