ANALYSIS-HMO deals seen heating up, but reform a wildcard

* 2010 seen bigger year for health insurer deals

* Room for consolidation seen after M&A lull

By Lewis Krauskopf

NEW YORK, Feb 8 (Reuters) - Health insurers are primed to rev up deal-making over the next year, although the prospect of even modest reforms to the U.S. health system may put a chill on acquisitions for the next few months.

Last year, debate over broad health reform created uncertainty over the shape of the insurance market -- making it difficult to make any strategic decisions -- while the companies also hoarded cash in the wake of the credit crisis and economic downturn.

With the improvement in the economy and markets, and with political developments leaving a massive overhaul of the health system less likely, expectations are that 2010 will be a bigger year for acquisitions.

"My sense is when reform clarifies, either enacted legislation or not, I think you will see a pickup in activity," Aetna Chief Financial Officer Joseph Zubretsky said in an interview. "I think the M&A environment all in ... will be a little more robust in 2010 than it was in 2009."

Analysts and company executives say the industry still has room for overall consolidation, as companies look to gain market share and leverage in local markets. Insurers that focus on Medicaid plans for low-income Americans -- a potential growth area -- also could be targets.

"Longer-term ... the companies that are going to perform the best are the ones that have the biggest scale, the best technology and the best medical care coordination," Edward Jones analyst Steve Shubitz said.

"Certainly, the smaller players over time will become more disadvantaged in that regard. Whether we have great reform now or some limited reform, there's going to be increased focus on containing costs and that accrues to the larger players."

While the uncertainty of health reform persists, large players such as WellPoint Inc and UnitedHealth Group Inc may choose to use their cash to buy back shares.

"These companies are not in any rush to make acquisitions," Shubitz said. "They're happy just to continue to get their pricing right, get their operations going good and basically buying back their stock."

The total value of announced deals with health insurers, as well as health services companies and providers, was $12.9 billion in 2009 and $10 billion in 2008, below the $31 billion and $44 billion in the preceding two years, according to Thomson Reuters data. The number of deals also slipped in the last two years.

"It seemed like nobody was going to make a move until they saw whether reform was really going to go through," said Bob Atlas, chief operating officer of Avalere Health, a research and strategic advisory firm.

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For a graphic on healthcare deals, click:

http://link.reuters.com/wys38h

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Since 2002, 14 publicly traded managed care companies have been acquired, according to Barclays Capital analysts.

But no managed care deal of at least $1 billion has been announced since November 2007, with Cigna Corp's acquisition of Great-West Health Plans for more than $1.5 billion, according to the Barclays analysts.

Managed care companies are starting 2010 with some of the lowest valuations seen in 20 years, the Barclays analysts said, an obvious catalyst for deals.

"There are many reasons that we believe the industry is poised for another period of accelerated consolidation," the analysts said in a research report.

Even though the top players control more of the health insurance market today -- the 10 largest companies controlled 27 percent in 1995, compared with 56 percent in 2008, according to WellPoint -- executives believe it remains fragmented.

"We continue to expect actually that our industry will consolidate over time," Cigna Chief Executive Officer David Cordani told analysts on the company's earnings conference call last week, where Cigna executives said acquisitions were the second priority for the company's capital after ensuring sufficient capital for its ongoing operations.

Cigna, and particularly larger rivals such as WellPoint, UnitedHealth and Aetna stand to be among the most likely buyers.

WellPoint CEO Angela Braly told Reuters in an interview last month that the healthcare reform focus has underscored the need to be efficient, and that efficiency comes in part through scale.

While smaller deals have been struck recently, Braly said, this year, "I think there will be more conversation about transactions that make great sense."

Other companies considered more regional players such as Coventry Health Care Inc could be buyers or maybe potential targets themselves.

"The big targets are fewer and further between, but there are some second-tier players that the larger companies might be interested in acquiring under the right circumstances," Atlas said.

"They already have state-of-the-art capabilities," he said. "What they'd be buying is growth opportunities."

Broad health reform legislation was set to expand Medicaid, a boost to the smaller insurers specialized in offering Medicaid plans, including Amerigroup, Molina Healthcare and Centene Corp.

Although the chances of such broad reform seems less likely, some analysts say Medicaid remains a promising area for growth.

"I would continue to think some of the Medicaid properties would be attractive regardless," Sanford Bernstein analyst Ana Gupte said. (Reporting by Lewis Krauskopf, editing by Dave Zimmerman)