The Health Care M&A Monthly September 2003

The Health Care M&A Monthly

In the September 2003 issue:

Pharmacy Benefits Managers: And Then There Were Three
Caremark Buys Advance PCS for $ 6 Billion

Caremark Rx has laid out plans to buy competitor AdvancePCS for $6 billion. This merger solidifies the surviving company’s position as the the second largest pharmacy benefits manager in the country in terms of revenue. At the same time, the transaction reduces to three the number of large PBMs.

Subsequent PBM consolidation will tend to involve smaller, regional PBMs. See page 1

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The Month in Deals
With 64 transactions announced during the past four weeks, deal volume is down slightly from the 66 deals in the comparable
2002 period.

Based on revealed prices, the combined amount spent to finance these 64 deals was approximately $9.2 billion. See page 3

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In The Departments

Deal Summaries Page 5

Additional Transactions Page 12

Transaction Updates Page 12

Read more about The Health Care M&A Monthly.

Read the past headlines.

Pharmacy Benefits Managers: And Then There Were Three

Containing spiraling drug costs has been on everyone’s mind, from Congress to the everyday consumer. While one wag quipped that Ashcroft’s office may be studying the movie "Canadian Bacon" in preparation for a raid on the Great White North to staunch the flow of lower-cost prescription drugs across the border into the U.S., others are pondering more seriously what can be done to rein in health care inflation driven, in large part, by escalating drug costs.

This month Caremark Rx (NYSE: CMX) and AdvancePCS (NASDAQ: ADVP), two of the largest pharmacy benefits managers in the country, weighed in with their solution: Join forces. True, the company that emerges from this merger will have greater clout in dealing with its suppliers and, theoretically, be better able to contain costs, but it will also find itself with fewer competitors, and perhaps less motivation, to negotiate the best price for its customers.

Let’s take a closer look. Rising from the ashes of the PPM industry, where it had been known as MedPartners, Caremark Rx now provides pharmacy benefits management services and therapeutic pharmaceutical services. Though currently based in Birmingham, Alabama, CMX is in the process of shifting its headquarters to Nashville, Tennessee, the de facto corporate capital of the for-profit health care services industry.

Caremark Rx serves approximately 20 million members through a network of 55,000 pharmacies, as well as through its own mail service pharmacies. Its customers generally include companies, unions, government health plans and, to a lesser extent, other insurers. In 2002 CMX managed over 91 million prescriptions from individuals from over 1,200 organizations.

To date, CMX has concentrated on internal growth. Its only recent acquisition of note was the April 2002 $48.5 million purchase of Choice Source Therapeutics, which expanded the company’s specialty distribution business. On a trailing 12-month basis, CMX generated revenue of $7.9 billion and EBITDA of $489 million.

Comparison of the top PBMs, as presented on page 3, reveals that Caremark Rx ranks fourth among the national providers. Clearly, it would like to capture a larger market share.

The result of the July 2000 $1 billion merger between Advance Paradigm and Rite Aid Corporation’s (NYSE: RAD) PCS Health Systems, AdvancePCS currently provides pharmacy benefits management services to 75 million plan members. Based in Irving, Texas, ADVP fills over 550 million prescriptions each year. Its client base includes managed care plans.

A fair portion of ADVP’s growth has come from acquisition. Besides its $1 billion acquisition of PCS, it paid $70 million in 1999 for Integrated Pharmaceutical Services, $72.6 million in 2000 for FFI Health and $100 million in 2002 for Accordant Health.

On a trailing 12-month basis, ADVP generated revenue of $14.7 billion, EBITDA of $395 million and net income of $183 million.

Under terms of the current deal, CMX will pay $5.6 billion in newly-minted shares of its stock and assume $400 million in liabilities. ADVP shareholders are to receive 2.15 shares of CMX stock for each share of ADVP common they hold. Based on their stock prices the day before the announcement, that ratio values ADVP stock at $54.61 per share, a premium of 37%.

Some analysts believe this price is somewhat rich relative to net earnings. However, other indices, such as the 0.41x price to revenue ratio, are more in line with historical transaction multiples for PBMs. The total price also yields a price to EBITDA multiple of 15.2x, a price per member of $80 and a price per prescription filled of $10.90.

CMX is to be the surviving corporation, with its current CEO as CEO of the combined organization. Not only has CMX management turned the faltering erstwhile PPM into a thriving company, but it seems better able to squeeze revenue out of its prescriptions. It seems to generate about $87 for each prescription while ADVP generates $27.

Upon consummation of the deal, Caremark would be the largest for-profit health care company headquartered in Nashville, surpassing hospital giant HCA (NYSE: HCA) in terms of annual revenue. While it would trail first place Medco Health Solutions (NYSE: MHS) in terms of annual revenue, it would surpass it in terms of prescriptions filled annually. This merger would also open the distance between CMX and third-place ExpressScripts (NASDAQ: ESRX).

Will this combination run afoul of antitrust concerns? If market share is measured in terms of prescriptions filled, probably not. After the deal, it is thought that Caremark would have a projected 20% of the market, just behind MHS’s 22% and ahead of Express Scripts 12%. However, strong regulatory scrutiny of this deal can be expected. If the impact of the merger is evaluated market by market, regulators may require the divestment of certain operations, although these would probably be minor in scope.

If this deal goes through, it may well signal the end of combinations of large PBMs for it is unlikely the FTC would sanction a merger of ESRX and MHS, reducing the field of national PBMs to two. Smaller deals will accordingly be the order of the day. It is estimated that there are now between 30 and 40 local or regional PBMs, many operating within a single state. These operations will create the pool of likely PBM acquisition candidates in the near future.

Nor do we expect to see much concerted M&A activity among PBMs going forward. Growth in the PBM industry will likely slow down, shadowing in effect the growth trends of their main suppliers, the big pharma companies. And policy makers will make some stabs at putting both big pharma and the PBMs under pressure to contain health care inflation due to prescription drug costs. Neither situation would appeal to investors.

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