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By Sabrina Jones
Washington Post Staff Writer
Monday, August 26, 2002
Magellan Health Services Inc. faces a bleak autumn as falling profit, a
declining membership and heavy debt threaten the turnaround of the
nation's largest provider of mental health care.
The Columbia-based company, saddled with rising
costs and a $1 billion debt, said this month that it expects to fall out
of compliance with its bank agreements by next month and may run afoul
of other terms of its debt agreements in the future. The agreements,
negotiated at a time when Magellan had more businesses and better cash
flow, require that the company's debt be no higher than five times its
earnings by Sept. 30, a level that has already been exceeded.
Magellan officials said they're trying to strike an agreement with the
banks on the company's debt restructuring, but there is no guarantee
that the issue will be resolved before next month's deadline. They said
the issue could prompt the company's auditors to express concern about
its ability to survive. Last week, Standard & Poor's cut its credit
rating for Magellan from B to B-minus, the second downgrade in three
months. S&P cited Magellan's recent quarterly earnings, troublesome
liquidity and financing concerns.
"We would hope we would be able to get some resolution prior"
to Sept. 30, said Melissa Rose, Magellan's vice president of investor
relations. "If we are in covenant violation, the banks could
accelerate our debt, and if they accelerate the debt, we would have a
liquidity issue. It would be difficult to meet our obligations."
Magellan faces a host of problems that, aside from its debt conundrum,
it must fix before it can return to a solid footing.
The company's costs of delivering care are rising 6
percent to 8 percent a year, due to the aftermath of the Sept. 11
terrorist attacks, a sluggish economy and people's growing comfort level
with therapy. Most of the demand is for outpatient treatment, such as
drug counseling and workplace support groups. But Magellan is hindered
from raising its prices quickly to stay in line with costs since only a
third of its contracts are renewed on a yearly basis. And it risks
losing future business as health plans, a large segment of Magellan's
customers, use acquisitions and other means to manage mental health care
benefits themselves.
"Assuming that there is less of a stigma
associated with behavioral health care, we think that utilization is
likely to remain higher than historic levels," Merrill Lynch &
Co. debt analyst Susannah Gray said in a report released this month.
"We think that Magellan will have to rely heavily on price
increases to preserve its margin. Given that only a third of its
contracts renew each year, these price increases may be difficult to
achieve quickly."
Magellan is asking its clients for price increases before their
agreements expire, and has boosted rates on its health plan contracts,
which renew annually. But that still may not be enough, analysts said.
Two of Magellan's largest customers, Aetna Inc. and TennCare,
Tennessee's health care program for 1.4 million poor and uninsured
residents, are struggling. In the first three months of this year,
Magellan lost 1.5 million members from Aetna, its largest client in
terms of members, and 200,000 to 300,000 more members since then.
Magellan said it expects to lose another 300,000 Aetna members by the
end of the year. The Aetna contract, whose renewal Magellan is now
negotiating, is scheduled to expire in December 2003. Magellan, which
covers about 90 percent of Aetna's roughly 15 million members, hopes to
resolve its contract with Aetna by next month, but there are still
risks. Aetna predicted its 2002 membership will fall to 13.7 million
members by December, according to a Securities and Exchange Commission
filing in June. The health insurer has taken steps to cut expenses, such
as eliminating 426 jobs between April and June.
"We're hopeful that we will retain the [Aetna] contract," Rose
said. "Just like any contract, Aetna will look at what options they
have. If Aetna were to be lost, there would be a short-term hit from
that from a financial standpoint. Over time, we would overcome
that."
Magellan recently won an extension of its TennCare
contract, which is its most profitable, generating $390 million a year
in revenue. But that agreement will also expire at the end of next year.
TennCare and Aetna generated about $564 million in revenue for Magellan
last year, more than 32 percent of the total.
But even with the TennCare contract renewal, Magellan has a formidable
challenge in keeping its rising expenses in line with its revenue, and
could suffer from its dependence on a few large customers for the bulk
of its revenue and members, some analysts said.
The company said it has been able to cut some costs, including about $5
million in annual savings this year, through layoffs, technology
improvements and other measures. Over the next two years, it says, it
hopes to reach $45 million in annualized savings. Next year, chief
executive Daniel S. Messina said, he will focus on a permanent solution
to the debt problems.
"We just simply don't want to be in a situation where every quarter
or every six months we're constantly dealing with different covenant
issues or bank issues," Messina said in a recent conference call
with analysts, investors and reporters. "We want to really have the
debt restructured in a fashion that will give us longer-term security in
that area."
Magellan's prowess in the behavioral-health-care market is one of its
main strengths, analysts said. It now accounts for 33 percent of the $4
billion market. Its clients include more than 3,000 health plans,
government agencies, unions and businesses. As of June 30, Magellan had
68.7 million members, compared with 69.4 million in the year-earlier
quarter.
Thomas H. Shinkle, a debt analyst with Imperial
Capital LLC of Beverly Hills, Calif., said he's optimistic that Magellan
will reach an agreement with the banks to avoid a default.
"They've got to see evidence that pricing is coming into line next
year, and a favorable resolution of the Aetna contract," Shinkle
said. "With that information, you can make projections that the
company is viable. It's got a massive market position, and it's a
substantial competitor. I don't think it's going away."
Still, Magellan's earnings problems persist. Its third-quarter income
dropped 34.2 percent, to $4.3 million, from $6.5 million a year ago. The
company's quarterly revenue inched up to $437.1 million, from $432.9
million in 2001.
Magellan has 6,010 employees, including 949 in Maryland. In the past
year, 388 people have been laid off throughout Magellan, including 73 in
Columbia. The company plans more layoffs for later this year as it
further consolidates its operations, but it has not specified how many,
Rose said. Judging by Magellan's stock price, investors aren't
optimistic. It closed Friday at 88 cents, down 3 cents. A year ago the
stock was trading at $14 a share.
Magellan began as Charter Medical Corp. in 1969 and
ran a group of psychiatric hospitals. In 1995, Charter changed its name
to Magellan Health Services and shifted its focus from providing direct
care to managing care. In the late 1990s, Magellan borrowed money to buy
three large managed mental health care firms -- Merit, Human Affairs
International and Green Spring -- and merged them into a single
behavioral-health division.
In the past few years, Magellan has sold businesses and ended
unprofitable contracts to focus on its core business of managing
psychiatric care and drug-treatment benefit programs for employers.
Elie J. Radinsky of Jefferies & Co. in New York
said Magellan has succeeded at selling off its noncore businesses, but
new challenges await it with higher-than-expected costs and more health
plans, such as WellPoint Health Networks Inc. and Anthem Inc., deciding
to handle their behavioral-health business internally, rather than
seeking outside vendors such as Magellan. But Magellan's plan to improve
its operations and pare down expenses has shown progress, Radinsky said.
"We have confidence that the management of Magellan should be able
to realize some significant savings," he said. "The challenges
that we believe Magellan faces are not one quarter in the making.
They're ongoing."
News researcher Richard Drezen contributed to this report.
© 2002 The Washington Post Company
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