Gene Marcial's Stock Picks

Marcial: Could Medco Make an Acquisition Soon?


Spun off by ( (MRK)) in August 2003, ( (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 ( (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 ( (CI)), ( (AET)), and ( (UNH)), may consider selling these units, as well. "Medco surely is a potential acquirer, along with ( (CVS))," the second-largest in the business, says analyst Glenn Garmont of investment firm . 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. aging population helps medco On the other hand, Aetna spokesman Fred Laberge told BusinessWeek that Aetna's PBM business is "an important component of its integrated value proposition, and we are exploring options that may provide value to our customers and shareholders." However, he adds, Aetna's policy is not to comment on rumors or speculation. Cigna spokesman Chris Curran told BusinessWeek the company constantly reviews its options and keeps in mind the best interests of shareholders and customers. The business has delivered strong results for Cigna, he adds. "If we are going to go down the path of [a sale]," says Curran, "it would be important that we do not dilute our ability to offer integrated clinical programs in the marketplace, because that is part of our competitive advantage." Internally, he adds, "we are evaluating strategic plans that work for our shareholders and the company." ThinkEquity's Garmont figures that Medco, exclusive of an acquisition, should earn $2.73 a share in 2009 on revenues of $61.4 billion, and $3.23 in 2010 on $65.6 billion, up from 2008's $2.33 on $51.2 billion. "A large acquisition might well be on the horizon" for Medco, figures analyst Andre J. Costanza of independent research firm Value Line ( (VALU)), who gives the stock the outfit's highest ranking based on its timeliness benchmark. He also rates the shares as an "above average" selection for safety and financial strength. Industry trends and an aging population are in Medco's corner, he says. He predicts the stock could double in three to five years. benefiting from patent expirations Analyst Phillip M. Seligman of Standard & Poor's ( (MHP)), who rates Medco a buy, says the company's healthy cash flow provides financial flexibility during tough times. The weak economy, he adds, continues to put pressure on overall drug usage. At the same time, however, that weakness also is spurring the increased use of generics and boosting prescription orders by mail, which save consumers money while helping the profit margins of PBM providers. Medco and its peers, notes Seligman, should benefit from the pending patent losses of additional brand-name drugs by major pharmaceutical companies. And he says proposed revisions to health-care reform now being debated, including an accelerated approval process for generic drugs, are mostly favorable to PBMs. What's favoring Medco is the continuing bright outlook for the fundamentals of the PBM sector, as health plans of companies, governments, and employers all seek to control and bring down the high cost of drugs and health services. Savvy investors may find Medco shares a prescription for profit as these trends play out. Unless otherwise noted, neither the sources cited in Gene Marcial's Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.
Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial's 7 Commandments of Stock Investing.

Burger King's Young Buns
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

Companies Mentioned

  • MRK
    (Merck & Co Inc)
    • $58.83 USD
    • 0.85
    • 1.45%
Market data is delayed at least 15 minutes.

Sponsored Financial Commentaries

Sponsored Links

Buy a link now!

 
blog comments powered by Disqus