Aetna analyst note projects AET/HUM merger approval and financial outlook

Aetna (AET) Kevin Fischbeck +1 646 855 5948 Research Analyst, MLPF&S Buy, PO $149 1Q investment thesis Based on past precedence, our view is that the AET/HUM deal is more likely than not to be approved by the courts (ruling likely to come in January 2017). PF 2018 earnings should be close to $11.50 (vs $9.70 consensus), even before taking into account the upside from tax reform (+15% to EPS} and rising interest rates (+5%). In the event that the deal breaks, we see little downside and potential upside in 1Q17 in the form of capital deployment (AET remains underlevered and in the absence of a deal could look to aggressively repurchase stock}. Current estimates do not include share repurchase and based on its history of repurchasing shares using free cash flow and its balance sheet capacity, we expect AET to repurchase a significant amount (~10%) of its shares in 2017 post deal break, providing initial downside support and ultimately driving upside to Street estimates. Table 1: Aetna key stock data Industry Managed Care Market Cap (mn) $44,657 Price $124.45 P/E (2017) 14.4x % of sell-side rated Buy 70.0% Short interest % of float 2.25% Source: Bloomberg and BofA Merrill Lynch Global Research estimates Deregulation/Gov't Legislation: Repeal and Replace of the ACA creates some uncertainty, but neither AET nor HUM derive a significant amount of EPS from the ACA. Meanwhile, Republicans have historically supported Medicare Advantage (80% of HUM’s revenue}, and we expect a stronger rate environment under this Administration than over the past 8 years. Tax Policy: As a domestic only company with a relatively high tax rate (est. 35% in 2017), AET would benefit from tax reform. We believe that some benefit would be lost to minimum MLR rebates or competition, but if taxes are lowered 15%, then we assume that they keep about 2/3 of the benefit (19% to EPS). Catalysts: Deal resolution, capital allocation update, tax reform, rising interest rates. Latest report: MCO rally has just begun; beneficiaries of the non-Health Care upside from Trump 1Q risks: Risks to the downside are courts not approving the HUM acquisition, lower- than-expected membership growth and higher than expected cost trend. CMS will issue the rate update for 2018 for Medicare Advantage in late February, a reg which we expect to be benign, but which could be worse than expected. Company Description: Aetna is one of the nation's largest managed care organizations, covering roughly 23 million members. The company focuses on three main business segments: Health Care (health insurance, dental, behavioral health and pharmacy benefit Bankof America <> Merrill Lynch Top 10 US Ideas Quarterly | 03 January 2017 3 HOUSE_OVERSIGHT_014624