The Health Care M&A Monthly: Express Scripts Buys NextRx--

$4.7 Billion Deal Makes ESRX Number Two PBM

Somewhat unusually, given recent trends in the health care M&A market, April’s largest deal occurred in one of the services sectors. More predictable, however, is that the assets involved in the deal would be crucially linked with pharmaceuticals. Express Scripts (NASDAQ: ESRX) announced its acquisition of NextRx, the pharmacy benefits manager, or PBM, business of the health insurer WellPoint (NYSE: WLP), for approximately $4.7 billion.

Based in St. Louis, Missouri, Express Scripts provides pharmacy benefit and medical information management services; it currently covers 50 million lives. On a trailing 12-month basis, the company generated $22.0 billion in revenue, $1.4 billion in EBITDA and $880.0 million in net income.

Until this deal, Express Scripts ranked third among national PBMs, behind the leader CVS-Caremark (NYSE: CVS), with its RxAmerica, LLC PBM business, and the runner-up MedcoHealth Solutions (NYSE: MHS). Comparisons of the top three are a bit dicey due to the fact that while MedcoHealth and Express Scripts are pure-play PBMs, CVS has a retail pharmacy segment, as well. CVS generates about $82.0 billion in revenue, about half of which comes from its pharmacy services segment while MHS generates annual revenue of about $51.0 billion. Other competitors include large managed care organizations (MCOs), which provide proprietary PBM services, or so the theory goes, to lower costs to the enrollees in their managed care plans.

But the MCO-PBM hybrids operate at something of a disadvantage to their pure-play PBM competitors since an MCO tends to provide PBM services just to its own enrollees, not to those of other MCOs. After all, competitors are unlikely to contract for your PBM product just to give you a leg up in the market. Accordingly, it makes sense to divest if your PBM program isn’t helping drive new clients to your business. This is probably part of the reasoning that prompted WellPoint to mull over divesting its NextRx PBM business. With 25 million members and EBITDA of about $1.0 billion, NextRx is the fourth largest PBM in the country. WellPoint has found a willing buyer in Express Scripts: the company was stymied in its attempt two years ago to acquire Caremark, which ultimately went to CVS in a deal valued at $26.5 billion and no acquisition premium.

As a result of this transaction, WellPoint, the country’s largest publicly traded health insurer by membership, will move that much closer to being a pure-play MCO. The company plans to use $2.0 billion of the sales proceeds to buy back stock, $500.0 million to pay down debt and $375.0 million for other corporate purposes. Express Scripts is offering $4.68 billion consisting of a combination of cash and up to $1.4 billion in shares of ESRX stock. The agreement includes a 10-year strategic alliance and contract for ESRX to provide PBM services to WellPoint’s membership. This will prevent erosion of the membership that ESRX inherits from WLP and will allow both parties to benefit from ESRX’s new economies of scale. Once consummated, ESRX will have 75 million PBM members, an increase of 50% of its membership that catapults it into second place ahead of MedcoHealth. The acquisition multiples are 4.7x EBITDA and $187 per member. Citigroup provided ESRX with financial advice, assisted by Credit Suisse Group AG and JPMorgan Chase & Co. Legal advice was provided by Skadden, Arps, Slate Meagher & Flom LLP. The deal has a break-up fee of $50.0 million.

As the dust from this deal settles, further consolidation within the PBM industry will most probably avoid a merger among the top three: CVS, ESRX and MHS. Any deal of this scope is guaranteed to attract the scrutiny—and censure—of federal antitrust regulators. We therefore expect that M&A activity in this industry in the near future will most likely involve smaller, add-on acquisitions.

And the ESRX-WLP deal may well set the paradigm for future dealmaking. At the very least, we believe that it will lead other large insurers, such as UnitedHealth Group, (NYSE: UNH), Aetna (NYSE: AET) and Cigna (NYSE: CIG), to fire up their calculators, punch in the cost-benefit analysis and ponder the strategic options for their in-house PBM operations.