Bloomberg News

Medco Offers 90% Return as Deal Seen Winning Approval: Real M&A

March 02, 2012

Drugs pass through a packaging machine at the Medco pharmacy plant in Willingboro, New Jersey, on Dec. 2, 2010. Photographer: Stan Honda/AFP/Getty Images

Drugs pass through a packaging machine at the Medco pharmacy plant in Willingboro, New Jersey, on Dec. 2, 2010. Photographer: Stan Honda/AFP/Getty Images

Express Scripts Inc. (ESRX)’s takeover of Medco Health Solutions Inc. (MHS) is offering the biggest potential windfall in North America even as traders are more confident than ever the acquisition will clear U.S. regulatory hurdles.

The gap between Medco’s share price and the value of Express Scripts’ cash-and-stock bid narrowed to $4.36 today, the smallest since the deal was announced in July, according to data compiled by Bloomberg. The transaction, valued at $71.71 a share yesterday, was still offering about a 90 percent annualized premium if it wins the Federal Trade Commission’s approval by the end of a 30-day review period that wraps up in two weeks, enabling the takeover to close as early as March 31, estimates Westchester Capital Management Inc. That’s the highest return among deals in the U.S. and Canada over $5 billion.

The takeover now has at least an 80 percent chance of closing as the FTC completes its investigation into whether the creation of the largest U.S. manager of prescription drug benefits would threaten competition, said Murphy & Durieu LP. Even those opposed to the $34.3 billion deal, including independent pharmacy rivals that suggested conditions for approval for the first time this week, are signaling regulatory signoff is increasingly likely, according to Jefferies Group Inc.

“If you haven’t been in it up to now, it’s a nice trade to play,” Jon Green, an analyst at Murphy & Durieu in New York, said in a telephone interview. “It gives somebody the opportunity to get a pretty healthy return.”

$34 Billion Deal

Today, Medco added 1.6 percent to $67.90 in New York, the biggest gain in the Standard & Poor’s 500 Health Care Index (S5HLTH), while Express Scripts posted the second-largest increase in the 52-company index at 1.3 percent. The discount to Express Scripts’ offer price narrowed to $4.36, the closest since the deal was announced, passing up the previous low of $4.41 on Feb. 29.

Lowell Weiner, a spokesman at Franklin Lakes, New Jersey- based Medco, and Brian Henry of Express Scripts in St. Louis, said they expect the deal to be completed during the first half of the year. Both declined to comment on how soon after potential FTC approval the deal could be completed or whether the companies were considering selling assets.

Mitchell Katz, a spokesman at the Washington-based FTC, declined to comment on whether the agency would approve the deal.

In July, Express Scripts agreed to pay $28.80 a share in cash plus 0.81 Express Scripts share for each Medco share held, the companies said at the time. Including net debt, the acquisition was valued at $34.3 billion, exceeding the $21.7 billion deal that formed CVS Caremark Corp. in 2007 as the biggest in the industry, according to data compiled by Bloomberg.

‘Relatively Competitive’

Traders who profit from mergers and acquisitions are becoming more confident the companies can convince regulators that a combination won’t hurt competition as smaller benefit managers win business from larger rivals, according to Will Harrington, a merger arbitrage analyst at Wall Street Access.

SXC Health Solutions Corp. (SXC) of Lisle, Illinois, said last week it was awarded a three-year, $1.2 billion contract to serve as pharmacy benefit manager for Blue Cross & Blue Shield of Rhode Island, replacing Woonsocket, Rhode Island-based CVS Caremark (CVS), the largest U.S. provider of prescription drugs that’s 13 times the size of SXC.

“The industry is relatively competitive and I think it’ll continue to be that way going forward,” Harrington, who’s based in New York, said in a phone interview. “I feel pretty constructive that they’ll be able to get this through and navigate the antitrust waters.”

‘Foregone Conclusion’

Before today, the spread between Medco’s stock price and the value of the bid had narrowed to a low of $4.41 on Feb. 29 from as much as $15.44 in August, data compiled by Bloomberg show, signaling that merger arbitragers became more confident than ever that the deal will be completed.

Opponents are also weighing in. David Balto, general counsel for the Independent Specialty Pharmacy Coalition, sent a letter to the FTC this week suggesting attaching conditions to any approved merger. Balto said the deal should be allowed only if the combined company lets customers buy specialty drugs at pharmacies that compete with their own.

It’s the first time the group, which would prefer the transaction be blocked, has proposed any conditions, signaling the takeover may be more likely to be completed, said Brian Tanquilut, an analyst at Jefferies in Nashville, Tennessee.

“I think that’s just him throwing in the towel,” Tanquilut said in a phone interview. “He’s seeing something that tells him this deal is a foregone conclusion and it’s going through.”

FTC Deadline

Balto, based in Washington, said his letter shouldn’t make investors more optimistic about the deal’s completion because Express Scripts and Medco may not agree to the terms.

“They should block the deal,” Balto said in a phone interview. “But if they’re considering doing some kind of remedy we think they should go and ban exclusivity arrangements.”

A decision by the FTC on whether to clear the proposal may come by early March, a person familiar with the matter said in February when Express Scripts was preparing to certify that it had delivered all the requested data. The agency is required to act on a merger request within 30 days of the certification and its options include clearing the deal, suing to block it or negotiating a settlement.

If the vote isn’t delayed and the FTC clears the acquisition, the companies may be able to complete the deal by the end of the month, said both Tanquilut and Roy Behren of Westchester Capital, which owns Medco shares.

‘Underestimating the Likelihood’

Express Scripts’ bid represented a 7.3 percent premium to Medco’s closing price of $66.85 yesterday. If the deal closes on March 30, the last weekday of the month, that would give traders who bought the stock at yesterday’s closing price a 91 percent annualized return, five times more than the next highest yield among North American deals bigger than $5 billion, data compiled by Bloomberg show.

“We have consistently thought that the market was underestimating the likelihood for successful completion of the deal,” Behren, who co-manages Westchester’s $5 billion Merger Fund in Valhalla, New York, said in a phone interview. “They could conceivably close this by the end of March.”

Steve Gerbel, founder and president of Chicago Capital Management, a Chicago-based hedge fund that focuses on merger arbitrage, said the risk of Medco losing as much as $15 a share if the deal falls apart outweighs the potential “big rate of return” if it closes by the end of March. He doesn’t own Medco shares.

‘Substantial Risk’

U.S. regulators have shown their willingness to break up deals over antitrust concerns in the last year. AT&T Inc. (T)’s $39 billion deal for T-Mobile USA, which would have combined the second- and fourth-largest U.S. mobile-phone carriers, collapsed in December after the Justice Department sued to block it.

Opponents of the Express Scripts-Medco combination say it will narrow patients’ pharmacy choices and raise drug prices. Wisconsin Democratic Senator Herb Kohl, chairman of the Senate’s antitrust subcommittee, has said the deal would reduce PBM choices for large employers.

“They probably will be able to work something out; however, it’s not done until it’s done, and there’s still substantial risk,” Gerbel said in a phone interview. “If you’ve done enough research to convince yourself that this is absolutely, positively going through, it’s a good trade. We just think the market is a little over-confident.”

While Express Scripts’ deal is still “on track” for approval, the FTC vote may be delayed as some divestitures are considered, MLex Market Intelligence reported this week.

‘Lining Up’

Even if the FTC’s review is extended, traders who bought Medco shares yesterday could still profit from at least a 22 percent annualized premium with the deal wrapping up by the end of the second quarter, the latest closing date projected by the companies, data compiled by Bloomberg show.

“People are treating this with a level of respect given the political rhetoric around it and the high-level merger review,” said Harrington of Wall Street Access. “It really comes down to what the Federal Trade Commission says.”

Still, “it is an opportunity,” he said. “It feels like things are lining up.”

To contact the reporter on this story: Charles Mead in New York at cmead11@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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