Our choice for deal of the month involves the acquisition of the country’s largest privately-held, independent pharmacy benefits manager, or PBM. In early February, as a kind of tenth anniversary present to itself, Express Scripts (NASDAQ: ESRX) announced a definitive agreement to acquire National Prescription Administrators (NPA), a New Jersey-based PBM, for the total price of $515 million. As government at various levels looks for ways to rein in the costs of prescription drugs to their constituents, many PBMs will increasingly seek to capture that promising market; some, as in this case, through acquisitions.
Express Scripts, based in Maryland Heights, Missouri, currently provides PBM services to approximately 47.5 million covered lives in the U.S and Canada. For 2001, ESRX earned $125 million on revenue of $9.3 billion, and generated EBITDA of $317 million.
As the chart on page 2 shows, ESRX is the third largest PBM, behind Advance PCS (NASDAQ: ADVP) and Merck-Medco Managed Care, LLC, a unit of Merck & Co. (NYSE: MRK).
No stranger to acquisitions, this is the fifth deal that ESRX has made in as many years. In 1998, it paid $445 million, or 0.34x revenue, to acquire ValueRx from HCA (NYSE: HCA, then Columbia/HCA). In 1999, it paid $700 million, or 2.7x revenue, to buy Diversified Pharmaceutical Services (DPS) from SmithKline Beecham plc, now GlaxoSmithKline (NYSE: GSK), paying a large premium virtually to double its size.
Two years later, after integrating DPS, ESRX entered the Canadian market with the $16.5 million acquisition of Montreal’s Centre d’autorisation et de paiement and its 1.5 million PBM members. Finally, in December 2001, Access Worldwide Communications (OTCBB: AWWC) sold the Phoenix Marketing Group (PMG) to ESRX for $35 million in cash and assumed debt. Based in Lincoln Park, New Jersey, PMG provides prescription drug sample fulfillment services, primarily to physicians’ offices.
However, neither of these last two deals served to bulk up ESRX’s membership, so it proposed acquiring NPA, the better to compete with Advance PCS and Merck-Medco.
NPA, based in East Hanover, New Jersey, is the country’s largest private, independent PBM. The business annually processes 42 million retail network claims and three million mail pharmacy claims for approximately 16 million members. The company’s geographic core market is in the Northeast and, significantly for ESRX, it counts among its major customers union- and government-sponsored plans.
It is estimated that for 2002, NPA will generate revenue of $2.1 billion and EBITDA of $53 million.
The assets to be acquired in this transaction include NPA, Central Fill, Inc., CFI of New Jersey, Inc., NPA NY IPA, Inc., as well as certain real estate and equipment.
In consideration, ESRX is offering a total of $515 million, consisting of cash, bank debt and the issuance of 552,000 newly issued shares of its common stock (worth $27.6 million).
This deal makes the price-to-revenue multiple 0.25x and the price-to-EBITDA multiple 9.7x. However, if the $90 million in cash that NPA brings with it is knocked off the purchase price, the two multiples deflate somewhat to 0.20x and 8.0x, respectively. After the deal, ERSX’s debt to EBITDA ratio will be a manageable 2.0x.
The transaction gives ESRX a considerable leg up in the Northeast PBM market, and will allow the company to accelerate sales to the union- and government-sponsored groups in which NPA specializes. This strategically positions ESRX to rapidly enter what could be a major market as local, state and federal governments move toward more concrete measures for providing substantive prescription drug benefits in the face of escalating drug costs.
But in the short-term, this deal will narrow the gap among the top three PBMs. After acquiring NPA, ESRX’s membership will be just 2% smaller than Merck-Medco’s and its revenues will be 10% less than ADVP’s. Caremark Rx (NYSE: CMX) will be a distant fourth.
Not so coincidentally, Merck is planning to spin off Merck-Medco Managed Care to its shareholders this year in what could be the largest health care IPO ever; in doing so, this could unleash some of the PBM unit’s bottled up potential. It would remove the stigma that Merck-Medco might have privileged MRK’s drugs in its formulary and would also immediately free Merck-Medco to pursue various deals with Merck’s pharmaceutical competitors with a clear conscience.
The market appears to hold out some hope for the PBM business. On news that it would spin off Merck-Medco, MRK’s stock rose 1.14%; the same day, ADVP’s rose 5.67%, CMX’s rose 3.35% and ESRX’s rose 1.41%. As the relative distance among the top three PBMs narrows, number four Caremark will be roughly one-third the size of the other three, and perhaps the most likely acquisition target among them all.