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Three analysts and top management from eight sector firms examine the managed care sector in this special 56-page Managed Care issue from The Wall Street Transcript, available at (212/952-7433) or http://www.twst.com/info/info564.htm

TWST: John, let’s start by looking at where the managed care industry stands today and the changes that have taken place over the past 12-18 months. The industry has embarked on what some might call a process of transformation. What would you point to?

Mr. Szabo: From a macro perspective, the fundamentals are very strong today. In fact, I think the fundamentals are as strong as I’ve seen them since I’ve been following the group. The key dynamic is pricing power. The group has demonstrated very strong pricing power over the last several years, but I think it really accelerated in 2002, and we’re seeing that reflected in stock prices today. I also think that for the first time in many years, there’s a reasonable chance that you could see a deceleration in medical cost trends. I believe the reasons for that are threefold.

TWST: John, what are your two top picks?

Mr. Szabo: My two top picks would be WellPoint (NYSE:WLP) and Cobalt (NYSE:CBZ). I think WellPoint is simply one of the best-managed companies I’ve ever come across in any industry. The company is run very tightly. Management held their investor conference a few days ago and Leonard Schaeffer noted that when Dave Colby, the CFO, came onboard, he remarked that WellPoint actually runs the company according to its annual business plan. I think that’s quite a statement actually. But the fundamental reason why we like it is they have a very strong position in California. They’re taking market share from some of the weaker players out there, whether it’s PacifiCare, Kaiser or Health Net, and I think that could continue for some time. I also like management’s geographic expansion strategy. They just bought RightCHOICE, the Missouri Blue, which also had a very nice multi-state ASO business called HealthLink, an outstanding management team, and very strong free cash flow. I think that’s going to be a highly accretive transaction for WellPoint. They also bought the Georgia Blue plan about a year ago and I think that’s paying dividends for the company. As the company diversifies geographically, I think the riskiness of its cash flows will decline and the valuation will improve. So we like that one.

TWST: How difficult is it for a company to enter a new market in which there are already other players?

Mr. Szabo: I think historically that’s been a difficult thing to do on a de novo basis, because the business requires a fairly high level of infrastructure building. You need to build out a network of providers, you need to build out sales and distribution, and that can be a costly endeavor. Also, you need to be competitive on a unit-cost basis, so you have to have enough size to be able to negotiate favorable rates from providers that are at least in line with the competition. So you haven’t seen the ability to expand on a de novo basis in this business as you might have in other industries. WellPoint has actually been reasonably successful with that, and their strategy was to acquire two national blocs of business, John Hancock and Mass Mutual. They used that large group business as a base to establish geographic concentration and then build out their small group and individual product, which is very profitable. So I think this company has a proven track record with acquisitions and market expansion that leverages their operating backbone and management expertise. The other company I would focus on is a smaller cap name, Cobalt Corporation, the Wisconsin Blue. The company completed its restructuring plan, converting to for-profit status last year, so it’s early in the process of making that transition from a not-for-profit to a for-profit company. And of all the companies we follow, this one has had probably the most earnings upside over the last several quarters as they make that transition. They’ve done it primarily through raising rates, negotiating better provider agreements, and working on the cost structure. It is the only publicly traded Blue plan that has made this conversion and is of a size that could be acquired by either Anthem or WellPoint. They’ve also divested some assets that were not generating an appropriate return, including their behavioral health business, and I think they have tremendous unrecognized value in their government processing business, which, depending on whether there are some legislative changes in Congress, could make that a more marketable asset. We think the stock is worth $26, and it’s currently trading at about $17 or $18.

This special issue includes:

1) Managed Care - In an in-depth (14,800 words) Analyst Roundtable, William McKeever, Managing Director at UBS Warburg, Joshua R. Raskin, Vice President and Senior Analyst in the Equity Research department at Lehman Brothers and John Szabo, Member of the equity research group covering healthcare services at CIBC World Markets, examine the outlook for the sector including industry changes, future role of HMO's and share specific stock recommendations.

2) CEO interviews (average 2,500 words). Top management of eight sector firms examine the outlook for their firm and the sector.