Sides Form on Medco-Express Scripts Deal

by Barry Cohen | August 2, 2011 2:38 pm

The great thing about opinions is that everybody has one. And in the case of the proposed acquisition of Medco (NYSE:MHS[1]) by its smaller rival Express Scripts (NASDAQ:ESRX[2]), multiple views about the wisdom of the deal and its likelihood of success dominate the conversation.

The questions surrounding the proposed $29 billion deal between the prescription benefit management companies have broad implications for investors. One big unknown is whether the U.S. government will OK the deal.

After all, combining the two would create a company involved in about a third of U.S. prescriptions worth more than $100 billion in spending, according to Atlantic Information Services, a health care data firm. As middlemen in the drug-supply chain, pharmacy-benefit managers (PBMs) play a huge role in the country’s $300 billion-plus yearly spending on drugs.

The U.S. Federal Trade Commission is likely to put the deal under a microscope because of concerns about anything that stands to drive up the cost of health care. The third big PBM, CVS Caremark (NYSE:CVS[3]), already is under scrutiny as the FTC is taking a close look at the company’s business practices. This investigation indicates the agency already is skeptical about the level of competition in the PBM market, according to David Balto, a Washington antitrust lawyer and former policy director at the FTC. Balto said Express Scripts and Medco “are in for a big fight.”

Two pharmacy industry groups hope the FTC kills or modifies the deal. The National Association of Chain Drug Stores and the National Community Pharmacists Association are concerned the combined company would be “too big to play fair, and will have immense power to unfairly dominate the market.”

Health care analyst John R. Graham thinks the government will bless the acquisition. Graham, the Director of Health Care Studies at the Pacific Research Institute in San Francisco, doesn’t think the takeover will come close to the FTC’s and Department of Justice’s threshold for concern.

Graham also thinks the Obama administration doesn’t like competition and fragmentation in health care and that a more concentrated PBM sector can be used to facilitate the government’s future rationing plans.

One Medco investor has come out strongly against the deal, but not for antitrust reasons. Rena Nadoff said Medco directors and executives breached their duty to get the best price before announcing the $71.36-per-share offer in cash and stock, according to a lawsuit filed July 22 in federal court in New Jersey.

If the takeover doesn’t go through, for whatever reason, some industry observers think the shares of both Medco and Express Scripts will take a beating, reasoning that the market already has priced much of the prospect of a deal into both stocks. Others think the industry’s best days are behind it and that even if the acquisition is OK’d, Express Scripts will underperform the market.

And in another twist, William Blair & Co. analyst Mark Miller raised his rating on Caremark to “Outperform” from “Market Perform” on the heels of the announced deal. He said the proposed acquisition could be good for Caremark because payers might be worried the deal will disrupt Express Scripts and Medco’s businesses, emphasizing that those payers could choose to do business with Caremark instead.

  1. MHS:
  2. ESRX:
  3. CVS:

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