UnitedHealth Group: Coming Clean?

UnitedHealth Group cut it close. One of the nation's largest health insurers waited to file its first-quarter report with the Securities and Exchange Commission until the evening of May 10, the last possible day it could without asking for more time. In the filing, the Minnetonka, Minn., company warns that it may have to restate earnings for the past three years because of a "significant deficiency" in the way it administrated stock-option grants. The warning comes nearly four years after the Sarbanes-Oxley Act mandated tighter controls on accounting and corporate governance.

If UnitedHealth has to pay taxes and interest on stock options it previously expensed, it will have to restate earnings. Based on its own investigation, the company estimates that this could reduce reported earnings by as much as $68 million in 2003, $110 million in 2004 and $215 million in 2005. The restatement estimates represent 2.3% to 4.5% of earnings depending on the year in question.

UnitedHealth, which says the SEC has launched an "informal" investigation into its stock-option grants, predicts that any accounting adjustments will not affect future earnings. The controversy "will likely linger until at least late June, when we expect the board investigation to wrap up -- possibly longer if the informal SEC inquiry turns into a formal inquiry," says analyst Edmund Kroll, of SG Cowen analyst, who is neutral on the stock.

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The uncertainty about stock-option practices and the SEC probe have battered UnitedHealth shares. Since mid March, when The Wall Street Journal reported that company executives had benefited from stock options given on extraordinarily favorable terms, the stock (symbol UNH) has dropped 24%, to $46. According to the Journal, each of 12 grants received by chief executive William McGuire between 1994 and 2002 were dated just before a large rise in the company's share price. McGuire has realized gains of nearly $200 million in the past four years from his options. He has a whopping $1.8 billion in unrealized gains from options he has yet to exercise. The company changed its stock-option compensation practices May 1.

Given the size of the restatements, UnitedHealth's problems are "overblown," says J. Paul Newsome of A.G. Edwards, who rates the stock a buy. "Our experience is that as long as the earnings impact is modest, the stock will largely recover over time," he says. However, Newsome worries that the scandal might force out McGuire, who has led the company for 15 years and presided over a steady rise in share price until recently. At $46, the stock trades at 16 times the $2.93 a share analysts estimate the company will earn this year, according to Thomson First Call. Newsome notes that it's trading at 14 times estimated 2007 profits, which is low compared with a price-earnings-ratio range of 15 to 26 over the past ten years. He thinks the stock is worth $60.

UnitedHealth shares may seem like a bargain to some, but they probably won't rise significantly until the company puts its stock-option problem behind it. And that could take a while.

--Thomas M. Anderson