INITIATING COVERAGE REPORT

William C. Dunkelberg Owl Fund February, 5

th 2014

Michael Lam: Lead Analyst mlam@theowlfund.com Ethan Friedland: Associate Analyst efriedland@theowlfund.com Niclas Dombrowski: Associate Analyst ndombrowski@theowlfund.com

Sector Outperform Recommendation: BUY

Key Statistics: Price $70.21 52 Week Low $52.51

Projected Return 20.80% 52 Week High $77.33

Shares O/S (mm) 1,010 Dividend Yield 1.5%

Market Cap $7,329 Enterprise Value $8,094

Earnings History: Quarters EPS Δ Rev. YOY Δ Price

1Q13 $1.16 11.21% -3.77% 2Q13 $1.40 11.53% 6.52% 3Q13 $1.53 12.17% -5.08% 4Q13 $1.41 8.09% -2.78%

Earnings Projections: Year Q1 Q2 Q3 Q4 Total

2011 $1.22 $1.16 $1.17 $1.17 $4.72

2012 $1.31 $1.27 $1.50 $1.20 $5.28

2013 $1.16 $1.4 $1.53 $1.41 $5.50

2014e $1.097 $1.332 $1.627 $1.546 $5.60

2015e $1.250 $1.509 $1.747 $1.679 $6.19

All prices current at end of previous trading sessions from date of report. Data is sourced from local exchanges via CapIQ, Bloomberg and other vendors. The William C. Dunkelberg Owl fund does and seeks to do business with companies covered in its research reports.

COMPANY OVERVIEW United Health Group (UNH) is the largest publicly traded managed care organization (MCO). UNH provides employers with products and resources to plan and administer employee benefit programs and services. UNH currently serves over 45 million members through a network of 780,000 physicians and 6,000 facilities. The United Healthcare segment (75.45% of revenues) includes

Employer & Individual: Private insurance for individuals and family members (39.5% of total premiums)

Medicare & Retirement: Government-run Medicare services to 50 + individual (38.8% of total premiums)

Community & State: Medicaid solutions to economically disadvantaged (16.1% of total premiums)

International: Private healthcare services to individuals and corporates in Brazil. (5.6% of total premiums)

The Optum segment (24.55% of revenue) includes

OptumHealth: Specialized health and wellness services (6.53% of total revenues)

OptumInsight: Provides process outsourcing, advisory, and data processing. (2.10% of total revenues)

OptumRX : Pharmacy benefits management business ( 15.9% of total revenues)

INVESTMENT THESIS UNH is currently trading at a discount to itself, its implied multiple against its peers, and its implied multiple against the S&P 500 Managed Care Index on a 10 year average P/E ratio. Historically UNH trades at an average 18% premium to its peers but is currently trading at a 7% premium. The depreciation of UNH’s multiples is due to funding cuts for the government run Medicare Advantage program, and uncertainty surrounding the implementation of the Affordable Care Act provision set to go live in 2014. However, UNH is still the largest publicly traded MCO that has developed above average operating performance through an economic moat developed through UNH’s industry leading size, diversified business units, switching cost, and moderate network effect. Moving forward, UNH’s continued growth and diversification via its Optum platform, the expected increase enrollment generated by the ACA, and other industry tailwinds will be significant catalysts. These catalysts will enhance UNH’s size and long term performance via above average margins and returns; which will restore UNH back to normal trading levels and result in an overall yield of 20.80% return.

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United Health Group, Inc. Exchange: NYSE Ticker: UNH Target Price: $83.83

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INDUSTRY OVERVIEW The managed health care industry is coming off a strong 2013 with

the S&P 500 Managed Health Care index raising 45.1%; offsetting a

4.9% increase in 2012. Moving into 2014, Managed Care

Organizations (MCO) will be faced with headwinds related to the

continued implementation of the Affordable Care Act (ACA). In

2014, Medicare Advantage plans will begin to face restrictions on

medical spending as a percentage of premiums (Medical Cost Ratio,

MCR), and operate through funding cuts. However consensus

estimates show that average annual enrollment gains could be as

high as 25 million by 2017 (primarily in Medicaid). Premiums and

fee revenue is expected to rise by an average of 9% in 2014 due to

higher premium rates on commercial and Medicaid plan, and an

expected increase in enrollment from over 11 million newly insured

individuals and Medicare enrollment. However, MCR is expected to

be higher as Medicare and Medicaid membership becomes a higher

portion of total membership and the rates are reduced for Medicare

Advantage. Expectations are that larger MCO’s will be able to more

readily navigate through these ACA changes by leveraging their

large membership base to efficiently spread costs.

CATALYSTS

Service Diversification: UNH continues to diversify its

exposure to the health insurance trends, ACA implementations,

and Medicare funding cuts through its Optum segment. The

segment offers higher margin business units with revenue

growth of at least 20%. The platform is unique to UNH and

should stabilize any fluctuation in earnings caused by ACA.

Industry Consolidation: ACA generated headwinds (such as

increased restrictions, competition, costs, and transparency

requirements) will lead to industry consolidation. Smaller

MCO’s will not have the resources to comply with these

changes or challenge larger MCO’s increasing enrollment and

scale. Thusly, leading to potential M&A activities

ACA Enrollment: Increase in enrollment is expected to be as

high as 25 million by 2016 for the industry. The increase

enrollment is expected to offset increases in MCR

requirements, non-deductible implementation costs, and

decrease in funding for government run programs.

Increase in Healthcare Expenditure: According to the

Center of Medicare and Medicaid Services (CMS), healthcare

spending represented 16% of total US GDP. At the current

growth rate, the CMS predicts that health care expenditures

could increase to 25% of US GDP in 2025 driven by an aging

population and changes in lifestyles.

Shareholder Returns: In FY2013 UNH paid out over $4

billion to shareholders via share repurchases and dividends.

UNH is expected to increase this amount in 2014.

RISKS

Increase in regulation: Government reform

on healthcare or changes in rates

requirements would have adverse effects on

profitability, and enrollment growth.

ACA Implementation: Requirements of

ACA calls for increased regulation,

transparency and competitive pressure.

Inability to comply will result in the erosion of

UNH’s moats, and industry leader status.

US Economy: Any slowdown or failures

would decrease employment growth, and

intensify budget debates. These two

developments would adversely affect

enrollment growth and health care spending.

Enrollment activity: If enrollment numbers

continue to come in lower than projected due

to poor execution of ACA mandates, then

growth forecast will drop dramatically.

ECONOMIC MOATS: Narrow

Size/Scale: UNH is the largest publicly traded MCO with over 45 million health plan members. The size of its membership bases allows for greater use of economies of scale and grants higher negotiating power to receive better terms with providers.

Diversification: UNH’s segments are further diversified into different sub segment. These sub segments limits UNH exposure to any changes in specific healthcare plans. More importantly, UNH’s Optum’s platform provides stability and diversification.

Switching Costs: Switching between health care coverage is time consuming, costly, and susceptible to tax penalties. Therefore, members tend to commit and remain with MCO’s that can provide a wide network at a reasonable rate.

Network Effect: UNH experiences a higher marginal gain with each incremental increase in its membership base and provider network. Expansion of its membership base increases flexibility, expands provider network, and creates more customized service plans.

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Affordable Care Act Overview:

Changes that have already been implemented include the inability for

insurance companies to raise premium payments without

government confirmation from the state government, mandated

MCR of at least 80% of premiums, and the inability to deny coverage

to those with pre-existing conditions. Implementations set for 2014

include the creation of health insurance exchanges, employer

mandates, and individual mandates. However, enrollment numbers

have come in lower than expected due to risk adverse actions by

MCO’s and the inability to provide the proper access mediums.

Insurance companies have been timid in participating in public

exchanges, where less than 2% of total revenues is generated from

these exchanges. The Congressional Budget Organization predicts that when fully implemented, the exchanges will

provide insurance for 7% of Americans. The White House claims that 6 million people have enrolled but, this figure is

combination of 2.1 million people who have enrolled under federal and state healthcare insurance exchanges and 3.9

million who have qualified for coverage on Medicaid. Information on the number of uninsured Americans will not be

issued till the March 31st enrollment deadline however the latest data issued showed that there was still 48 million or 15.4%

of American without health insurance. March 31st deadline will be the start of the individual and employer mandates

where uninsured individuals will face a tax penalty, and employers who do not provide insurance will face a fee.

Expectations are that 80 percent of Americans will get their insurance through an employer or the government

(Medicaid or Medicare). The remaining 20% must purchase health insurance or pay a tax penalty, when fully phased in

by 2016 will reach as high as $695 per individual or 2.5 percent of income. In order to avoid paying a tax penalty this

year, purchases must be made by by Feb. 15 for a start date of March 1. (Insurance purchased on March 15 would not

start until April 1, one day too late to avoid the penalty.) The Congressional Budget Organization’s budget outlook

predicts a late enrollment surge in the next couple of months. The CBO’s also expressed fears that the ACA will reduce

full-time employment by 2.5 million jobs by 2024 due to the expectations that employer will develop a higher

unwillingness to hire and employees wanting to cut back on hours in order to receive government subsidies. However,

many health insurance CEO’s remain highly optimistic at the growth prospects and have taken on certain initiatives to

ensure they can navigate through and capitalize on ACA changes.

PEER GROUP IDENTIFICATION

Aetna Inc. (AET) o Provides health care benefits in US through its Health Care,

Group Insurance, and Large case pension segments

Cigna Corp. (CI) o Provides health services and insurance though its

commercial, government, group disability, and global

supplemental benefits, and run off reinsurance segments

Humana Inc. (HUM) o Provides insurance product, and health services through its

retail, employer group and health care services segments

Health Net, Inc. (HNT)

o Provides managed care services through commercial,

Medicare, Medicaid, and other sponsored products

WellPoint Inc. (WLP) o Provides network based managed care plans through its

commercial, consumer, and other segment

TARGET PRICE

The target price is derived from first identifying the 10

year average premium that UNH historically trades at

against its peers. The premium factors are multiplied by

the individual peer’s NTM P/E, and averaged together

to yield a target multiple of 14.95x. The target multiple

is multiplied by consensus NTM EPS of $5.61 per share

to yield an $83.83 price target. Factoring in the

company’s dividend yield of 1.50% results in a total

projected return of 20.80%.

Peer Analysis Target Price= $83.83

Relative Target Multiple = 14.95.x NTM Forecasted EPS = $5.61

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FINANCIALS

Revenue

Total revenue has grown at a CAGR of 8.89% since 2009 and is projected to grow at a CAGR of 7.06% for the next 3

years. Expectations are that growth in total revenue will be driven by increased enrollment numbers, and high growth

levels from the Optum platform.

The United Health segment has grown at a CAGR of 8.30% since 2009. The segment is expected to continue growing at

due to increase enrollment created via ACA. UNH total enrollment for 2013 was roughly 45 million, and represents an

increase of 11.7%. Within the last 4 years UNH experienced an increase

of 14 million to its membership base.

Employer & Individual: decreased by 3.43% YOY due to a large customer conversion from risk based to fee based service that resulted in a decrease of 2.3 billion or 4.86%.

Medicare & Retirement : grew by 12.4% YOY driven by double digit grout in enrollment for its Medical Advantage, Medical Supplement Products, and Medicare Part D plans

Community & State: grew by 12.47% YOY due to state re-procurement in Tennessee and renewals/expansion in Hawaii.

International: reported revenue of $6.4 billion in its first full year of operating.

The Optum has grown at a CAGR of average 16% since 2009. In 2013,

Optum revenues grew by 26% driven by double digit growth in each of

its three sub-segments.

OptumHealth: grew by 21% YOY, due to the strong performance in local delivery care.

OptumInsight: grew by 10% YOY due to growth in revenue management services provided through Optum 360

OptiumRX: grew by 31% YOY due to a combination of services expansion to external clients, completing the transition of services for current members, and a 46% increase in script volumes.

Margins:

Gross margin has grown from 25.1% in 2009 to 27.1% in 2013, EBITDA margin grew from 8.1% in 2009 to 9.0% in

2013, and Net margin has grown from 4.4% in 2009 to 4.6% in 2013. However, all three operating margins for 2013

were slightly down versus its 2012 numbers due to increase in commercial risk enrollment, and ACA regulation

compliance. Overall margins have remained consistent since 2009; which is a testimony to the company’s ability to

properly manage costs and to the growth of the industry. Operating margin in the United HealthCare segment was 6.4%

and represents a 1.2 % decline due to funding reduction in its Medicare Advantage products. Operating margins in

Optum was 6.25% and represents a 1.35% increase due to growth and effective management of its sub segments.

OptumHealth: operating margin of 9.9%, a growth of 3.02 % YOY due to an improved cost structure.

OptumInsight: operating margin of 19.0%, a growth of 2.2% YOY due to growth in revenue management services provided through Optum 360 (revenue cycle management)

OptiumRX: operating margin of 3.06%, a growth of .92% YOY due to pricing discipline, cost management, and improvement in its generic based mix.

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Medical Cost Ratio (MCR)

Medical Cost ratio is measured as the average medical spending as a percentage of premiums. ACA mandates have set

MCR floors to be at 80% to ensure that members are getting high quality treatments. UNH historically maintained a

consistent MRC within 1% of 80%, where as its peers have struggled with the same task. In FY 2013, UNH announced

a spike in MRC from 80.4% in 2012 to 81.5% in 2013 due to expected reductions in Medicare advantage funds, a shift

toward more government run membership mix, ACA transitional and implementation costs, and higher commercial risk

enrollment. With its industry leading membership base and extensive provider network, UNH should be able to

effectively spread out costs to continue posting lower than industry average MCR.

Administrative Expenses Ratio

Administrative Expenses ratio is measured as the firm’s total administrative expenses divided by total revenue or total

premiums. The ratio represents how efficiently UNH is managing non-medical related cost and is a measure for the

effectiveness of its non-medical related operations is in generating incremental gains in enrollment. UNH’s

Administrative ratio has been increasing in the past couple years to 15.8% in 2013 from 15.2% in 2010. The increase is

attributed to increase spending in its Optum business as opposed to a decrease in efficiency.

Earnings:

UNH has not missed earnings estimates since the 4Q 2008 and beats these estimates by an average of 8.6%. Earnings

have grown at a CAGR 14.14% since 2009 and are projected to grow at a CAGR of 7.86% till 2016. For 2013, earnings

growth can be attributed to UNH’s high annual growth in enrollment in the last few years (14 million in the past four

years), growth in its Optum platform (61% YOY growth in operating income), and expansion into Brazil via its

acquisition of Amil. Management’s EPS guidance for 2014 is $5.40 – $5.60 which represents a modest growth of 1.83%.

Free Cash Flow:

From 2009 to 2013 FCF increased at a CAGR of 4.5% and is expected to

grow at a CAGR of 6.7% from 2013 to 2016. Growth in FCF will be

driven by CFFO growth where enrollment growth and sales growth from

the Optum platform will make the largest contribution to growth. CFFO’s

has grown at a 5.58% CAGR since 2009, and projected to grow by 6.14%

CAGR for the next 3 year. CAPEX have been projected to grow at 9.7%

as the UNH continues to invest in the growth of Optum and comply with

changes to ACA.

Company 2013 2012 2011 2010 MRC Admin MRC Admin MRC Admin MRC Admin HUM 83.7% 15.1% 83.7% 15.1% 82.1% 14.8% 82.9% 13.2% WLP 87.8% 15.0% 85.1% 14.2% 85.3% 14.4% 85.1% 14.1% CI 82.9% N/A 79.6% N/A 80.5% N/A 82.3% N/A HNT 89.1% 11.0% 89.1% 8.6% 86.5% 8.6% 87.1% 8.5% AET 82.2% 18.8% 82.2% 18.3% 79.6% 19.7% 82.3% 19.4%

Median 83.7% 15.1% 83.7% 14.7% 82.1% 14.6% 82.9% 13.7% Mean 85.1% 15.0% 83.9% 14.1% 82.8% 14.4% 83.9% 13.8%

UNH 81.5% 15.8% 80.4% 15.6% 80.8% 15.3% 80.6% 15.2%

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Shareholder Return

UNH paid out about $3.2 billion for share repurchases in 2013, buying over 48 million shares at an average price of

$65.60 per share. In June 2013, the board of directors increased and renewed a repurchasing program where 110 million

shares may be repurchased. Dividends paid out in 2013 equate to $1.1 billion for a 29% growth YOY. Dividends yield

has been increasing since 2009, with a 3 year average growth of 28.16%. UNH’s dividend payout ratio currently is 18.8%;

which is double the value of its 2010 ratio, and a 4% increase from 2012. Management expects to again return more

than $4 billion to shareholders in 2014 through the completion of its current share repurchase programs and an increase

to its dividend.

Invested Assets:

UNH’s total investment income in 2013 was $21.54 billion, a YOY

growth of 5.6%. Since 2009, total investment income has grown at a

CAGR of 10.7%. UNH’s portfolio consists of US Government and

Agency Securities (13.07% of total investments), State and Municipal

Securities (32.27%), Asset and Mortgage-Backed Securities (13.55%),

and Corporate Debt Owned (37.84%), and Corporate Owned Equity

(3.26%). UNH’s investments strategy is focused on a safe long term

income approach. With interest rates expected to increase, UNH has

committed larger portions to low duration securities and reallocated

more of the allocation in securities that are not as sensitive to interest

rate risk.

Debt:

UNH’s Debt/Equity (D/E) and Debt/Capital (D/C) was reported at 50.6% and 33.6% which are in line with its peer

group’s average. UNH experienced an increase in its D/E to 50.59% from 2011 to 2012 due to the acquisition of Amil.

The long-term debt portion represents about 88% of total debt; where 12% ($1.9 billion) is due within the next year.

UNH’s liquidity level is not as strong as its competitors, where its current ratio of 0.73 is below the comp group average

of 1.33. However, UNH historically operates with a current ratio below 1.0, and have utilized a $3 billion revolving line

of credit and cash flow from operations of about $7 billion to finance its current liabilities. Additionally, with an interest

coverage ratio of 13.59 UNH is able to pay its debt obligations.

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VALUATION

Undervaluation

With a significant amount of the ACA expected to go live in 2014, investors are have become overly cautious about the

uncertainty surrounding ACA’s effect on operational performance. Headwinds such as the expected decrease in

Medicare Advantage funding, a decreasing pricing trend, and expected ACA taxes/implementation costs have been

major contributors to the company’s depressed multiple. Other headwinds include uncertainty with state acceptance of

certain programs, the slow development of public exchange markets, and the changes in healthcare spending in relation

to expected increase in enrollment. Non-healthcare related headwinds such as expectations for a correction and the

Federal Reserve’s tapering have also contributed to the deprecation of the stock.

UNH historically trades at a premium to its comps and the S&P 500 managed Care Index due to UNH’s ability to

generate higher returns at a lower MCR via its stable economic moats. On a 10-year average, UNH traditionally trades at

14.40 times earnings but currently trades at 13.15x, representing an 8.68% discount from its normal trading level.

Against the S&P 500 Managed Care Index, UNH trades at a 12% premium versus the index on a 10 Year average P/E.

However, UNH is currently trading at 1.0% premium to the index on a P/E basis.

Peer Group Valuation

The companies used in the relative valuation include Aetna Inc. (AET), WellPoint Inc. (WLP), Cigna Corp. (CI), Health

Net, Inc. (HNT), and Humana Inc. (HUM). The peer group includes companies that operate as a Managed Care

Organization within the United States, and have significant exposure to Medicare and Medicaid. On a 10 year average,

UNH trades at an 18% premium against its peers on a P/E basis. This premium is attributed to UNH’s larger size and

higher efficiency; where UNH’s profitability ratios and operational margins are higher than its peer’s group averages.

However, UNH is only trading at an average 7% premium due to the reasons stated above. Through the catalyst stated

in the previous section, UNH’s multiples should expand back to normal trading levels; resulting in an 11% multiple

expansion to an implied forward P/E of 14.95x. Using the implied forward P/E multiplied by consensus EPS estimates

of $5.61 per share yields a price target of $83.83. After accounting for a dividend yield of 1.50%, the total return equates

to 20.80%.

Implied P/E

• 14.95x

Consensus EPS

• $5.61

Target Price

• $83.83

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APPENDIX:

UNH: 10 year P/E

UNH vs Comp. : 10 year P/E

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UNH benched against comps : 10 year P/E

UNH benched against comps : 3 year P/E

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DISCLAIMER

This report is prepared strictly for educational purposes and should not be used as an actual investment guide.

The forward looking statements contained within are simply the author’s opinions. The writer does not own any

United Healthcare Group, Inc. stock.

TUIA STATEMENT

Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his

tireless dedication to educating students in “real-world” principles of economics and business, the William C.

Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,

practical learning experience. Managed by Fox School of Business graduate and undergraduate students with

oversight from its Board of Directors, the WCD Owl Fund’s goals are threefold:

Provide students with hands-on investment management experience

Enable students to work in a team-based setting in consultation with investment professionals.

Connect student participants with nationally recognized money managers and financial institutions

Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs

and partial scholarships for student participants.