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Express Scripts to buy Medco for $29 billion

By Lewis Krauskopf

NEW YORK (Reuters) - Express Scripts Inc will buy rival Medco Health Solutions Inc for $29.1 billion, creating a U.S. powerhouse in managing prescription drug benefits that is sure to draw antitrust scrutiny.

The deal would be the biggest ever in the healthcare services industry and give Express Scripts close to one-third of the pharmacy benefits market, gaining much more leverage for negotiating drug prices for employers and other clients who must reduce their exposure to spiraling healthcare costs.

The industry's expertise in managing pharmacy spending has made its services all the more attractive and lured new competitors like insurer UnitedHealth Group.

The deal would also give the combined company greater clout against drugstore chains like Walgreen Co and increase competition with the likes of CVS Caremark Corp.

"They would be more than twice as big as their next largest competitor," Morningstar analyst Matthew Coffina, referring to CVS. "Scale is really what matters in this business in terms of bargaining power relative to suppliers, the ability to operate mail order facilities and process claims efficiently."

Express Scripts will pay $71.36 per Medco share, a 28 percent premium to Medco's closing price on Wednesday. Medco shareholders will receive $28.80 cash and 0.81 of an Express Scripts share for each Medco share they own.

Medco shares closed up just 14.4 percent at $63.83. The gap between the offer price and Medco's share price reflects skepticism that U.S. regulators will approve a deal that would whittle the large industry players down to two from three. Coffina gave it a less than 50 percent chance.

"It's like a coin flip right now about whether it gets approved or not," Gabelli & Co analyst Jeff Jonas said.

Express Scripts is an experienced acquirer, having struck more than a half dozen sizable deals since 1998, though this would easily be its biggest. It recently finished integrating its roughly $4.7 billion purchase of the drug benefits unit of insurer WellPoint Inc. In 2007, Express Scripts failed in a bid to wrest away Caremark from CVS.

Express Scripts shares closed up 5.4 percent at $55.36.

ANTITRUST ARGUMENT

Pharmacy benefit managers, or PBMs, administer drug benefits for employers and health plans and also run extensive mail-order pharmacies.

The Medco-Express Scripts deal would create a company with 1.6 billion annual prescription claims, while CVS Caremark would be second at 940 million, said JMP Securities analyst Constantine Davides.

"There will be an antitrust hurdle to clear," Davides said. "It will take a while on the regulatory front, but it's a consolidating industry."

Express Scripts Chief Executive Officer George Paz, building a defense against antitrust concerns, said the combination would reduce the ballooning healthcare costs that have helped fuel the U.S. budget deficit.

"This is a transaction the nation needs now," Paz said on a call with analysts. "We wouldn't be doing this if we didn't think we didn't have a very good chance of getting this through."

Sharon Treat, a Maine state legislator who has been critical of PBMs, said the industry was concentrated even before this deal.

"It's more likely to increase the prices that consumers pay when they go to a pharmacy to fill their prescriptions," said Treat, who is also executive director of the National Legislative Association on Prescription Drug Prices.

The Medco-Express Scripts agreement provides for a break-up fee in certain circumstances, but not in the event of failure to obtain regulatory clearance.

MEDCO UNDER PRESSURE

Medco, the bigger company in terms of revenue, suffered a major setback in May when it lost a big pharmacy benefits contract to CVS. That came soon after Medco lost a contract with Calpers, the biggest U.S. public pension fund.

On Thursday, the company said its account with UnitedHealth, which represents 17 percent of Medco's revenue, would not be renewed. UnitedHealth is building up its own drug benefits business and stands to become a serious competitor.

"Given the attrition risk Medco faces over the next few years, in regard to the UnitedHealth contract going away in 2013 and other publicized losses, (the Express Scripts pact is) a good deal for Medco and their shareholders," Davides said.

Medco said on Thursday its quarterly profit fell 4 percent to $342.8 million, while total prescription volumes rose 0.5 percent. Express Scripts said its net profit rose more than 15 percent to $334.2 million.

At 10 times Medco's earnings before interest, taxes, depreciation and amortization, the deal is in line with previous acquisitions in the PBM industry valued at 10 to 12 times EBITDA, Jonas said.

Credit rating agency Standard & Poor's revised its outlook on Express Scripts to negative after the deal's announcement, citing significant integration risk in addition to its "temporarily stretched" financial risk profile.

On completion of the transaction, Express Scripts shareholders are expected to own about 59 percent of the combined company, with Medco shareholders owning the rest.

The combined company's corporate headquarters will be in St. Louis and Paz will be chairman and CEO. The board of directors will be expanded to include two current independent Medco board members.

Express Scripts projected $1 billion in cost savings, about 1 percent of the combined company's costs. It said the deal would slightly add to earnings in the first full year after closing, which is expected in the first half of 2012.

(Reporting by Lewis Krauskopf, Bill Berkrot and Ransdell Pierson; additional reporting by Diane Bartz in Washington, Ben Hirschler in London and Renju Jose in Bangalore; Editing by Michele Gershberg, John Wallace, Tim Dobbyn and Bernard Orr)

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