The Cigna Group (CI-NYSE, $300.58) Walks Away From a Takeover/Merger with Humana Inc. (HUM-NYSE, $472.88).

In a happy turn of events, Cigna management decided to end all negotiations with Humana Inc. on a combination.

I have argued, backed by volumes of capital markets texts, that one of the most destructive capital markets transactions is a relative merger of equals, insofar as market caps are concerned, when the target is a high P/E business featuring historically average rates of growth, while the acquirer is a low P/E company with similar rates of growth and that relies upon share equity as the primary currency to complete the transaction.

The risk in such cases comes about via the need to pay out a takeover premium that further increases the price to earnings ratio of the target beyond a level that makes any fiscal sense. Yet, because mergers and acquisitions oriented investment houses on Wall Street earn their annual bonuses via a steady flow of deals; their goal is to promote a transaction of any sort, whether or not it makes fiscal sense. While some investors and institutions look for M&A actions as a positive, I take the opposite view; I hate M&A because of the risk of capital destruction for the acquirer.

Any potential tie-up of Humana , a relatively high P/E business with moderate growth potential and a heavy dependence upon government reimbursement for the majority of revenues, by Cigna, a very low P/E company with roughly equivalent rates of growth, made zero sense to any detached observer. In a world where M&A firms could be prevented from gaining access to the executive offices at any major corporation with prudent gatekeeping, such deals just wouldn’t even get floated and the world would be a better place for it.

Despite having zero merits on paper, some M&A persons, apparently, did gain access to the top levels of the executive branch of Cigna. They worked their sales promotional toolkit enough that management of Cigna, after a 5+ year hiatus, came disastrously close to providing a total takeover premium + M&A fees in the $18-$20 billion range. Based upon the underlying profitability of Humana, payment of such a premium would eat up the next 4-5 years of profits to be earned by Humana, and that doesn’t even take into account the time value of money.

Had institutional holders not stood up for themselves, apparently threatening heads on spikes were Cigna to cave to pushy dealmakers, M&A firms would be high-fiving all throughout the Christmas holidays and sourcing out expensive real estate in the Caribbean for their bonuses.

While $20 billion doesn’t represent as much blown-up capital as it once was, it is still an enormous chunk for Cigna, a company with a market cap, pre-takeover talk, of about $90 billion. The decision to walk away seems easy enough, but begs the question as to why it even happened at all. I speculate that Cigna didn’t seek out Humana; rather, the deal was brought to them externally. Such a view suggests that Humana is shopping their business. One typically does not shop a steadily growing firm, unless internal models suggest that the future growth rate may diminish for a variety of reasons. Shopping an entire firm, whose primary business is government payor based health plans, may portend ill for certain sectors of the health insurance business in general in 2024 and beyond.

Cigna shareholders have dodged a bullet, yet the process highlights an important part of the allocation framework that needs to be considered by any investor.

Regardless of how much work one can put into finding a suitable investment for one’s portfolio, no matter how sensible an investment might appear to be; any thesis can be completely upended by a capital market decision. No investor should expect that their individual ambitions are completely synchronized with that of a CEO or the board of directors of a business they own. The potential for destructive acquisitions should always be considered within the framework of a portfolio. While not a universally accepted given, it is my view that capital market transactions tend to have greater, potentially deleterious, impacts upon companies with lower EBITDA margins. Companies with relatively low EBITDA margins also tend to operate in industries that are more freely competitive.

Going forward, Cigna management claims to have “rediscovered” religion.

After the disastrous 4 years that ensued from the vast overpayment premium made for Express Scripts, the executive of Cigna had kept their heads down and largely avoided the flurry of M&A transactions, both larger and smaller, that are characteristic within the US health care industry.

Based upon this Humana experience, it seems that the reason Cigna served as a bystander in the transactional deal-flow of the past 5 years in health care was not entirely due to a lesson learned, but rather, from a lack of cheap cash to do a deal. With interest rates being where they are, capital access is no longer cheap and a business with a lower EBITDA margin lacks the ability to make expensive purchases and obtain profit accretion. Maybe, just maybe, those running Cigna went to church pretty regularly but didn’t really listen to the sermons and instead, spend every Sunday thinking about what they could do if they were 2x their size. I purchased Cigna, years after the Express Scripts acquisition, once that steep takeover premium had finally been overcome with profit, with the understanding that management had learned from that painful period, only to learn that what they had offered, was, to some degree, merely lip-service.

The upshot of this stinging rebuke, by the institutional holders of Cigna, is that a chastened executive will be shying away from destructive deals for the immediate future. Instead of giving tens of billions to Humana shareholders, Cigna will be taking most of their profits, to be earned in the coming 24 months, and directing it towards a fairly significant share buy-back. As much as $10 billion will be added to the current buyback plan. This could conceivably reduce the outstanding count by about 38 million (at current market values).

The 2024 and beyond earnings forecasts by Wall Street have yet to model a potential 15% reduction in the share count of Cigna when calculating the future EPS.

What has not yet been said, but should be considered, is that a failure of Humana to sell itself to what was hoped to be a “sucker” could represent a negative for those firms within the health care industry who obtain most of their revenue from government payor programs. Perhaps, just perhaps, the growth trajectory of health insurers is slowing and if that is the case, then this large share repurchase program by Cigna may not have as much impact on future EPS, providing earnings growth from the underlying business diminishes, in the near term.