A top insurer gets the options flu
UnitedHealth Group had an outstanding reputation to go along with its thriving business. Then the backdating scandal slammed its stock.
By Yuval Rosenberg, Fortune

(Fortune Magazine) -- A good name is better than riches," wrote Cervantes. It's a lesson that William McGuire, CEO of UnitedHealth Group (Charts) may be learning. Under McGuire, who became chairman and chief executive in 1991, UnitedHealth has earned a reputation as the best-run medical insurer, a smart strategic player, and a first-class innovator. The company has grown its customer base from 1.4 million to more than 70 million and rocketed revenues from $847 million in 1991 to $45 billion last year and a projected $72 billion for 2006. Profits, meanwhile, zoomed from $75 million in 1991 to $3.3 billion last year.

That outstanding record was reflected in our 2006 ranking of America's Most Admired Companies, as UnitedHealth again placed at the top of its industry - and bested its health insurance competitors in every one of the eight categories we consider. Not only that, but among the companies most admired for innovation, UnitedHealth ranked third overall, behind Apple Computer (Charts) and Google (Charts). It has excelled at using technology to create new revenue streams and improve customer service.

Now, as we begin preparing for our next list of Most Admired Companies, and with UnitedHealth embroiled in the scandal surrounding the backdating of stock options, we wanted to take a closer look at what the company's troubles mean for investors.

The stock, after all, is trading 19% below its 52-week high, and analysts note that operations remain solid. "The performance of the business fundamentally is stronger than it ever was," says Sheryl R. Skolnick, an analyst with CRT Capital Group. So is this an opportunity to get a fallen star on the cheap?

Perhaps, but only for those willing to endure a long and potentially bumpy road. If management can stay in place, the stock could have a $7 to $10 upside, says Robert Smith, manager of the T. Rowe Price Growth Stock fund (Charts), which has more than 2% of assets in UnitedHealth shares.

That "if" is a big one, though. Results of internal and government investigations into the backdating of stock options are still pending, and UnitedHealth had to delay filing of its second-quarter earnings. A board committee is reviewing more than 45,000 options grants given to some 15,000 people over 13 years, according to the company. Among the options under review are those granted to CEO McGuire, who has reaped profits of $333 million since 1994 and has another $1.8 billion in unrealized gains.

The company has said the review could result in "significant" noncash charges. "You have that superior track record in question, and you have the management team that brought you that superior track record in question as well," says A.G. Edwards analyst J. Paul Newsome, who downgraded the stock from a buy to a hold after the filing delay was announced.

So while UnitedHealth's business might be humming along, Wall Street is likely to remain wary of the company, analysts say. "Do investors respect this company as much as they did a year ago?" asks Skolnick. "I can't believe that they do. Nor do I think they should."

And though shares are now well off their highs, they still look relatively expensive. UnitedHealth Group trades for nearly 18 times estimated 2006 earnings, compared with 16.6 times for Wellpoint (Charts) and 14.4 times for Aetna (Charts). Even after the options accounting is made clear this fall, it might take months or years for the company to recover its reputation. That means investors may be better off looking elsewhere for now.

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UnitedHealth Group ranks No. 116 on FORTUNE's 2006 Global 500

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