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Coventry Healthcare Earns Bullish Review

Zacks Equity Research

Following the news of Coventry Healthcare Inc.’s (CVH) imminent acquisition by Aetna Inc. (AET), several credit rating agencies - Standard & Poor’s (S&P), Moody’s and Fitch Ratings - have placed the ratings of Coventry on review with a positive outlook, according to sources.

The rating agencies believe that the acquisition by Aetna will be beneficial for the company and, therefore, have indicated the possibility of an upward revision in ratings.

Aetna is a substantially larger company compared to Coventry, with a stronger market position and a higher credit rating. Coventry currently has a counterparty credit rating of “BBB-” (one notch above junk status) from S&P, issuer default rating of “BBB” (two notches above junk status)  from Fitch and senior debt rating of “Baa3” (one notch above junk status) from Moody’s.

However, S&P has revealed that it expects to raise the rating on Coventry to “BBB+” within a year. This is only one notch below Aetna’s rating. However, the rating is open to revision based on Coventry’s financial results until the closure of the acquisition. Furthermore, the debt rating on Coventry’s debt is expected to be raised to the level with Aetna’s debt rating after the acquisition as the latter will take over the entire debt of the former.

The optimistic outlook by the rating agencies reflects their view that the acquisition will be beneficial for Coventry and consequently, its credit quality. Following the acquisition, the company is expected to be considered as a strategically important subsidiary of Aetna.

Aetna signed an agreement to acquire Coventry for $7.3 billion, earlier this week. The purchase consideration also includes the takeover of the latter’s debt.

Per the agreement, shareholders of Coventry will get $27.30 in cash and 0.3885 Aetna common shares for each Coventry share, or $42.08 per share, based on the closing price of Aetna common shares on Friday, August 17. Aetna is expected to issue $2.5 billion of debt and use the existing cash in hand to finance the deal, which is likely to close by mid 2013.

However, when the news of the proposed takeover broke, Coventry came under fire with a number of investigations leveled against it. Law firms Rigrodsky & Long, P.A., Newman Ferrara LLP, Ryan & Maniskas, The Briscoe Law Firm PLLC, Powers Taylor LLP, Levi & Korsinsky LLP, Robbins Umeda LLP, Faruqi & Faruqi LLP, Glancy Binkow & Goldberg LLP and many others announced investigations against the company’s Board to determine whether it performed its fiduciary duty by ensuring the best possible pricing for the company, as they consider the premium to be low.

The law firms are concerned that the Board might have failed to maximize shareholders’ value by under-pricing the deal. The allegations arise as the Board did not auction Coventry in the open market. Moreover, it agreed to pay a huge termination fee in case the company cancels the agreement to accept a better offer from a competing company. The firms are also worried that Coventry might have failed to disclose all material information to shareholders.

Coventry carries a Zacks #3 Rank, implying a short-term Hold rating. We maintain a long-term ‘Neutral’ recommendation on the stock.

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