Marcial: Could Medco Make an Acquisition Soon?

The nation's biggest pharmacy benefit manager may be in the market for a deal to keep its lead in the highly competitive field

Medco Health Solutions—52-week price

By Gene Marcial

BW's Gene Marcial

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Spun off by Merck (MRK) in August 2003, Medco Health Solutions (MHS) has become the largest U.S. pharmacy benefit manager (PBM), and now it may well make a large acquisition to make sure it stays ahead of the pack in the fiercely competitive but highly profitable industry.

That's the buzz since Express Scripts (ESRX) agreed in April to acquire WellPoint's (WLP) NextRx pharmacy benefit unit for $4.6 billion. (The deal is expected to close at yearend.) The market's reaction to the impending acquisition has been positive, so analysts believe other major insurers that run their own pharmacy benefit services, such as Cigna (CI), Aetna (AET), and UnitedHealth Group (UNH), may consider selling these units, as well.

"Medco surely is a potential acquirer, along with CVS Caremark (CVS)," the second-largest in the business, says analyst Glenn Garmont of investment firm ThinkEquity. Aetna and UnitedHealth, he notes, have not publicly acknowledged an appetite for such an alternative. But Cigna indicated at a recent conference that it's open to the possibility of doing something strategic with its pharmacy benefit business, says Garmont.

boost to earnings?

"Medco certainly has the financial wherewithal to contemplate acquisitions," says Garmont. "We believe management would jump at the opportunity, given the significant synergies that may be realized from…combinations in the PBM sector," he says. Medco spokesman Lowell Weiner says, as a matter of policy, the company doesn't comment on speculation about acquisitions or mergers.

Garmont rates Medco a buy based on its strong fundamentals and current "compelling valuation." The stock, which hit a 52-week low of 29.80 on Oct. 27, 2008, had climbed to 43.68 by June 16. He predicts the shares will hit 54 in 12 months based on fundamentals alone. Should Medco make an acquisition, that would be an added bonus, because a deal will only enhance its revenue and earnings growth, says the analyst.

According to Garmont's possible scenarios, an acquisition by Medco of Cigna's pharmacy benefit business would add 3% to 4% to its earnings per share in 2010. Earnings could get a 4% to 5% boost if Medco bought Aetna's PBM unit, and an 11% to 15% lift from UnitedHealth's unit, he figures.

"We characterize a Cigna deal as the most likely of the three, and a UnitedHealth transaction the least likely, although we have not heard that anything definitive is in the works," says Garmont. He says that applying his valuation targets for Medco, based on pro forma earnings estimates in an acquisition of Cigna's PBM unit, the fair value price that such a deal could yield for Medco's stock in 12 months is in the range of 57 to 63.

UnitedHealth declined to comment.

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