Bloomberg News

Medco Bulls Stuck With Losses Even If Takeover Closes: Real M&A

September 06, 2011

Sept. 7 (Bloomberg) -- Medco Health Solutions Inc.’s most- bullish investors will be stuck with losses even if Express Scripts Inc. wins government approval for its $31.6 billion acquisition of the pharmacy-benefits manager.

Medco shareholders who purchased the stock at $65.96 -- the peak since the takeover by Express Scripts was announced on July 21 -- won’t profit if the cash-and-stock deal closes at the current offer price, which has declined 13 percent to $65.57, according to data compiled by Bloomberg. Investors who owned shares of Franklin Lakes, New Jersey-based Medco the day before the acquisition was announced have already lost 5.4 percent as Medco tumbled, the data show.

With the U.S. Justice Department’s lawsuit last week to block AT&T Inc.’s acquisition of T-Mobile USA heightening concern among some investors that the Express Scripts-Medco deal will get scuttled, Medco shares are now trading 19 percent below the bid. That makes it the most likely U.S. takeover of more than $1 billion to fail, data compiled by Bloomberg show. Tullett Prebon Plc and Havens Advisors LLC are still betting the deal will withstand a review from the Federal Trade Commission, which last week made a second request for information.

“The long-only investor who got in early is going to get burned,” Yemi Oshodi, managing director of M&A and special situations trading at New York-based WallachBeth Capital LLC, said in a telephone interview. “In a situation like this, you have to be hedged.”

Cash-Stock Deal

Express Scripts of St. Louis agreed to pay Medco holders $28.80 a share in cash and 0.81 Express Scripts share for each Medco share held, the companies said in a July 21 statement. When it was announced, the acquisition valued Medco at about $34.3 billion, including $4.9 billion in net debt, data compiled by Bloomberg show.

Since July 22, when the deal was valued at a high of $75.21 a share, the price tag has fallen to $65.57 as Express Scripts shares plunged 21 percent, the data show. If the takeover were to close at the current price, traders who bought Medco stock at $65.96 on July 22 would lose money.

Medco has fallen 20 percent to $52.79, wiping out $6 billion in market value since July 22, according to data compiled by Bloomberg. The drop exceeded the 13 percent decline for the Standard & Poor’s 500 Index during the same period. Since the day before the purchase was made public, Medco’s market capitalization has shrunk by more than $1.9 billion.

‘Too Much Risk’

“If you got in early, you have to realize there are times where you make mistakes and things go against you,” Keith Moore, an event-driven strategist at MKM Partners LP in Stamford, Connecticut, said in a telephone interview. “The people who hedged their bets could potentially make their money back, but it’s more likely that the government is going to have a big issue with this merger. It’s a huge spread and I’d love to be able to get excited about it, but there’s too much risk.”

Regulators want to learn more about the combination before signing off, Express Scripts said in a Sept. 2 filing with the U.S. Securities and Exchange Commission, disclosing that the FTC made a second request for information. Medco and Express Scripts also notified the Justice Department of the transaction.

Together, the two largest companies that handle drug benefits for corporate and government clients will have a 28 percent market share, according to BB&T Capital Markets. The acquisition would exceed the $21.7 billion deal that formed CVS Caremark Corp. in 2007 as the largest in the industry.

Not ‘Gun Shy’

The transaction may have a more difficult time gaining approval after the Justice Department sued AT&T to block the $39 billion acquisition of Bonn-based Deutsche Telekom AG’s T-Mobile USA unit, said MKM Partners’ Moore. The Justice Department said Aug. 31 that a combination of Dallas-based AT&T and T-Mobile, which would create the nation’s biggest wireless carrier, would “substantially” reduce competition.

“The AT&T suit shows that Obama’s antitrust enforcers are not the least bit gun shy about going to court to stop an anti- competitive merger like this,” David Balto, a Washington-based antitrust attorney and former FTC policy director, said in a telephone interview.

Balto, who is working with organizations opposing the Medco takeover, pegged the odds of the deal gaining approval as currently structured at less than 50 percent and said the second request may take four to nine months.

Lowell Weiner, a spokesman for Medco, declined to comment on the regulatory process or the company’s stock movement.

Antitrust Review

“Although the timeline for the antitrust review process is not fixed, we are confident of a positive review and we anticipate the merger will close, as expected, in the first half of 2012,” Brian Henry, a spokesman for Express Scripts, said in an e-mail. “We believe this merger will further improve patient health and safety, control costs and, for our clients, foster an environment that promotes growth and job creation.”

Even though the spread between Medco shares and the deal price has widened, the FTC’s second request for information wasn’t a surprise, Bill Kavaler, a New York-based special situations analyst for Oscar Gruss & Son Inc., said in a phone interview. He projects the FTC will approve the purchase.

“Everybody that’s betting on this deal happening was also betting on this getting a second request,” Eugene Goldenberg, an analyst at BB&T Capital in New York, said in a telephone interview. “Now it’s primarily going to come down to the FTC decision.”

Merger arbitragers are still more likely to make a profit on the Express Scripts-Medco deal than so-called “long-only” investors who bought shares and didn’t hedge the purchase, Sachin Shah, a special situations and merger arbitrage strategist at Tullett Prebon in Jersey City, New Jersey, said in a phone interview. Arbitragers will typically sell the acquiring company’s stock short while buying shares of the target.

Deal ‘Suffering’

“The Medco transaction is suffering right now, but every arb should have it fully hedged,” Nancy Havens-Hasty, president of New York-based merger arbitrage fund manager Havens Advisors, which expects the deal to close, said in a telephone interview. “Anybody who doesn’t is much more vulnerable.”

Short interest in Express Scripts rose 68 percent since the acquisition was announced through last week, according to London-based research firm Data Explorers. Short selling is the practice of selling borrowed stock on the bet the price will decline.

Medco, which had already lost at least $3.5 billion in contracts this year prior to the takeover, may now be dropped next year by its sixth-biggest client, Blue Cross and Blue Shield of North Carolina. The health insurer’s contract generated about $1.6 billion annually, Barclays Plc estimated.

‘Dead Money’

“With the loss of those contracts, that’s going to unnerve a few people because you just don’t know what the new downside is,” WallachBeth Capital’s Oshodi said. “Arbitragers and investors are trying to determine what the new unaffected price of Medco is.”

Even though investors have lost money on the deal since it was announced, Tullett Prebon’s Shah said he’s confident it will pass muster with U.S. regulators and close by mid-2012. By then, the broader market will likely have recovered, and the deal will be worth more, he said.

“If you bought it on day one or in the first couple of weeks before the market meltdown and increased volatility, then you are down,” Shah said. “It’s maybe somewhat dead money between now and until we get some clarity. Most of the people playing this know it’s dangerous to just be long Medco though without any hedge.”

--With assistance from Molly Peterson in Washington and Michael Tsang in New York. Editors: Sarah Rabil, Daniel Hauck.

To contact the reporter on this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.


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