The Health Care M&A Monthly: Hostilities Erupt on the Institutional Pharmacy Front!

What appears to be the year’s first major hostile takeover bid in the domestic health care arena arrived in late May. Omnicare (NYSE: OCR) has targeted rival NeighborCare (NASDAQ: NCRX), offering to buy the company for $1.5 billion.
Omnicare is the largest provider of institutional pharmacy services in the country, serving approximately one million long-term care beds. On a trailing 12-month basis, OCR generated revenue of $3.7 billion, EBITDA of $477 million and net income of $217 million.

Buy and Grow
Omnicare attained its premier position through a slew of acquisitions. Although the majority of targets were institutional pharmacies, other business lines such as contract research organizations were also bought. We have tracked 69 of OCR’s deals over the past decade. Eighteen of the most prominent among them are tabulated in the chart on page 3. Comparison with these historical deals shows that the acquisition of NCRX would be OCR’s largest by far.

NeighborCare was once part of Genesis Health Ventures (GHV), which began life in 1985 as an operator of skilled nursing facilities, or SNFs. In the years since, GHV expanded its operations to include assisted living facilities and ancillary services such as contract therapy and, naturally, institutional pharmacy services. While GHV had rebranded its services "eldercare" to reflect this expanded offering, two segments, management of SNFs and providing institutional pharmacy services, accounted for the bulk of its operations.

Genesis’ institutional pharmacy business grew by acquisition, as well. In April 1996, GHV paid $57.3 million, or 1.1x revenue, for NeighborCare Pharmacies. In October 1997, as part of its acquisition of The Multicare Companies, GHV bought Multicare’s institutional pharmacy operations for $50 million. It was the next year, however, in April 1998, that Genesis made its great leap forward into the institutional pharmacy world by paying $680 million, or 1.4x revenue, to buy the publicly traded company Vitalink Pharmacies.

Stall and Split
Not longer after, Genesis shared in the string of financial meltdowns, bankruptcies and reorganizations that plagued the long-term care industry around the turn of the millennium (remember all those SNFs it operated?). It began operating out of bankruptcy in October 2001, which meant a shiny new set of shareholders, management and board members. The company was then split down the middle to better its chances of survival, with NeighborCare emerging in December 2003 to operate GHV’s institutional pharmacy unit while Genesis HealthCare Corp. (NASDAQ: GHCI) inherited the residue of its senior care operations.

Arising from the Ashes
It may have been at the urging of the post-bankruptcy regime that Genesis split up into the more profitable institutional pharmacy business and the iffier eldercare business. That would certainly go a long way to providing a satisfactory exit strategy for those investors who had ponied up the money to rescue GHV from bankruptcy. When former Genesis was split in two on December 1, 2003, each GHV shareholder received 0.5 shares of what was to become the successor company, NeighborCare. The highly leveraged eldercare business became Genesis HealthCare. Major shareholders of NCRX—as well as GHCI— when they became independent, included Highland Capital and entities associated with it, which collectively hold at least 24% of NCRX stock. The investment banking firm of Goldman, Sachs held another 7.94% of the pie, which it has reduced by more than 60% since to just 1.3 million shares.

Today NCRX’s current pharmacy operations consist of 62 institutional pharmacies, 32 community-based professional retail pharmacies and 20 on-site pharmacies, which are located in clients’ facilities and serve only customers of that facility. In addition, NeighborCare operates 16 home infusion, respiratory and medical equipment distribution centers. It currently serves about 246,000 institutional pharmacy beds in 32 states.

On a trailing 12-month basis, NeighborCare generated revenue of $2.03 billion, EBITDA of $104.5 million and net income of $19 million. NCRX’s revenues are geographically concentrated along the Rust Belt: Maryland, New Jersey, Ohio, Pennsylvania, Virginia and West Virginia together account for 62% of the company’s revenue. Just one customer accounts for 14% of its revenue.

Omnicare Launches A Takeover Bid
Clearly, Omnicare wants to leave no doubts that it is top dog in the institutional pharmacy business. Adding NCRX’s quarter-million long-term care beds to the one million it already services would certainly accomplish that. It launched a hostile bid at the end of May, reiterating the same terms that it apparently had presented to NCRX’s board earlier this year.

OCR offered to pay $30.00 in cash for each share of NCRX stock outstanding, or about $1.31 billion. If you factor in NCRX’s debt on top of that, the purchase price rises to about $1.5 billion. That price yields a price to revenue multiple of 0.72x , price to EBITDA multiple of 14.4x and a price per long-term care bed of $6,098.

OCR’s proposal offered NCRX shareholders a 70% premium over the stock’s price the day before the offer was made. On news of the offer, however, NCRX’s stock rose 54% to $27.45, clipping the premium offered to 9%.

So far, however, NCRX has demurred. In a conference call, the board unveiled a business plan which they predicted would generate an estimated EPS of $0.85 to $0.90 for 2004, $1.35 to $1.60 in 2005, going as high as $3.30 to $3.65 by 2007. Legg Mason projected EPS of $0.97 for 2004 and $1.30 for 2005, but its crystal ball stopped there. All this potential value, NCRX argued, was not fully reflected in OCR’s offer.

OCR responded to these prognostications by stating that they had made a generous offer when NCRX’s stock price was relatively high and did not drop it when NCRX’s stock tanked after its first quarter earnings announcement. In doing so, OCR emphasized the volatility of stock in a company that has been trading as an independent entity for just a short time, and offered the certainty of cash now rather than possibly unrealized promises down the road.

True, part of NCRX’s resistance may also stem from some bad feelings that arose when the two butted heads in late 2002 over the purchase of NCS HealthCare. NeighborCare—then Genesis—had bid $340 million for NCS, but had the rug pulled out from under it when OCR blindsided them with a $460 million hostile counterbid and ultimately prevailed. Whatever history the two companies may have, NCRX’s current management and board appear bullish about its prospects. Although they claim not to be entrenched, and thus working in the shareholders’ best interests, the board and management, it appears, want to stay directly involved in guiding NCRX’s business, and not be put out on the street, as they would be, by accepting OCR’s all-cash offer.

Show-Down
In its eagerness to pursue the deal, Omnicare may have been the first to blink. One reason it gave for doing the deal is that according to OCR’s president and CEO Joel Gemunder, "We expect the transaction to be significantly accretive to Omnicare’s earnings per share." Hmm, we can hear NCRX’s board reason, if this deal is going to be so significantly accretive to OCR’s earnings, maybe it would provide Mr. Gemunder with more than enough cash flow to sweeten his company’s original offer. And since NCRX is used to getting better returns per long-term care bed it serves than OCR, it would want to be properly compensated for it. (After all, while OCR services three times the number of beds NCRX does, that still translates into just 45% more in revenue.)

Although it has not taken the precaution of identifying a white knight to block OCR’s bid, NCRX may yet entertain an enhanced offer. We suspect that NeighborCare’s board and shareholders might blink back if the offer is revised into the $35 to $40 per share range, and maybe some board seats and stock are thrown into the mix for good measure. Mr. Gemunder may have to up the ante and do more than offer shareholders’ a quick cash fix. And with NCRX’s stock reaching $32.09 in mid-June, the market appears to believe that there is room to sweeten the terms.