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Medco Takeover Seen Making SXC Priciest Target: Real M&A

Medco Deal Seen Turning SXC Into Most Expensive Target
The gap between Medco’s share price and the value of Express Scripts’s $34 billion offer this month reached the narrowest since it was announced in July, signaling traders are confident the deal will close, according to data. Photographer: Emile Wamsteker/Bloomberg

March 27 (Bloomberg) -- The increasing likelihood that Express Scripts Inc.'s acquisition of Medco Health Solutions Inc. will succeed is now turning SXC Health Solutions Corp. into the industry’s most expensive takeover candidate.

The gap between Medco’s share price and the value of Express Scripts’s $34 billion offer this month reached the narrowest since it was announced in July, signaling traders are confident the deal will close, according to data compiled by Bloomberg. Buying SXC, which is projected to boost profit by than 80 percent in the next two years, would allow rivals to better compete against a company that will dominate the $200 billion U.S. drug-benefits management market.

While SXC is trading at 30 times analysts’ 2012 earnings estimates, about twice the industry median, the Lisle, Illinois-based company’s growth may attract suitors from UnitedHealth Group Inc. to Catalyst Health Solutions Inc., according to Wall Street Access and Leerink Swann LLC. By acquiring SXC, which also is one of the biggest providers of technology for processing prescription claims, a buyer would gain a company that is estimated to increase revenue 60 percent by 2013, the data show.

“SXC is a bit pricey, but they’re potentially winning large amounts of business,” David Larsen, a Boston-based analyst for Leerink Swann, said in a telephone interview. With the pending Express Scripts-Medco deal, “the ability to gain leverage and scale in the pharmacy benefit management space is very important. SXC has a terrific platform,” he said.

Tony Perkins, a spokesman for SXC, declined to comment on whether the company has been approached by any buyers within the pharmacy-benefits management, or PBM, industry, or is considering a sale.

Negotiating Prices

Tim Pearson, chief financial officer of Rockville, Maryland-based Catalyst, didn’t immediately respond to a telephone message and e-mail seeking comment, while Tyler Mason, a spokesman for Minnetonka, Minnesota-based UnitedHealth, said the company doesn’t comment on takeover speculation.

Founded as Systems Xcellence in 1993, SXC negotiates with drugmakers for lower prescription medicine prices on behalf of health insurers, Medicare and Medicaid plans, workers’ compensation programs and long-term care facilities. The company also makes software that processed one out of every five drug claims in the U.S, according to the company’s 2010 annual report.

With traders now betting that the Express Scripts-Medco deal will clear Federal Trade Commission hurdles to create the largest U.S. manager of prescription drug benefits, SXC may emerge as a takeover candidate as acquisitions in the industry accelerate, said Will Harrington, a New York-based merger arbitrage analyst at Wall Street Access.

More Deals

“It feels like things are lining up and it appears that FTC approval is more likely than not at this point” for Express Scripts’ Medco purchase, Harrington said in a telephone interview. “Usually when you see a consolidating industry like this, it doesn’t stop with the one sizeable deal.”

The gap between Express Scripts’ cash-and-stock offer and Medco’s stock price has narrowed in the past month, data compiled by Bloomberg show.

After trading more than $10 a share below the offer in February, Medco rose to within $2.34 a share of the takeover price on March 14, closer than at any time since the acquisition was announced on July 21, the data show. Medco ended at $69.50 a share yesterday, less than 4 percent below the current value of its agreement with Express Scripts.

Larger Rival

SXC could lure a larger rival such as UnitedHealth, the biggest U.S. health insurer by sales, which is investing in its PBM unit as the $57.6 billion company prepares to take back some business it had farmed out to Medco in recent years, Harrington said.

“SXC’s interesting because it’s one of the sizeable independent PBMs and they also have a little bit of a health-care technology component to them,” Harrington said.

The $4.5 billion company also could combine with a similar-sized competitor such as Catalyst, putting the new entity in a stronger position to negotiate prices with manufacturers, according to Leerink Swann’s Larsen. Buying SXC would help Catalyst almost double its sales and widen its lead as the third-largest PBM provider, according to data provided by Bloomberg.

After boosting its forecasts for sales and earnings per share for the year ended in December, the company reported 2011 results last month that exceeded analysts’ estimates. The company’s shares climbed 28 percent this year through yesterday for the second-biggest gain after Rite Aid Inc. in Bloomberg Industries’ North American Health Care Supply Chain Index.

Most Expensive

Based on yesterday’s closing price of $72.38, the company was valued at about 30 times its projected earnings for this year, the most among 12 U.S. companies involved in the supply chain for pharmaceuticals or medical equipment with market capitalizations greater than $500 million, according to data compiled by Bloomberg. The median multiple for the group is about 15, the data show.

Including net debt, the company was valued at 25 times earnings before interest, taxes, depreciation and amortization. The multiple, more than double the average for the group, is also more than twice the 11.34 times Ebitda that Express Scripts offered for Medco, the data show.

While a takeover of SXC wouldn’t be cheap, the company deserves a higher valuation because sales and earnings will continue growing, said Leerink Swann’s Larsen.

Earnings Gains

Analysts are projecting revenue will climb about 60 percent to almost $8 billion in 2013 after more than doubling last year as the company made its own acquisitions and was awarded new contracts. During the same period, Catalyst’s revenue is estimated to rise by half as much, data compiled by Bloomberg show.

SXC’s net income, which rose in seven of the last eight years, will increase 83 percent by 2013 to a record $168 million, according to the average of analysts’ estimates compiled by Bloomberg.

The company said last month that it won a three-year, $1.2 billion contract for Blue Cross & Blue Shield of Rhode Island, replacing Woonsocket, Rhode Island-based CVS Caremark Corp., which is more than 13 times the size of SXC with a market value of about $59 billion.

Potential suitors may also want SXC’s information-technology division, which would hand a buyer relationships with 30 to 40 other PBMs and the opportunity for further consolidation, said Brooks O’Neil, a Minneapolis-based analyst for Dougherty & Co. SXC’s technology unit in October signed a five-year renewal to supply Catalyst with its claim software.

Buying, Not Bought

While the software unit made up all of SXC’s revenue just five years ago, it accounted for only 2.3 percent, or $116 million, of sales last year as pharmacy-benefits management comprises the larger portion, data compiled by Bloomberg show.

Constantine Davides, an analyst for JMP Securities in Boston, said SXC can benefit more from buying its smaller competitors rather than selling itself. Bulking up its PBM business may even make it a more attractive takeover target in the years ahead, he said.

SXC announced at least three acquisitions last year, including its $250 million purchase of Greenwood Village, Colorado-based HealthTrans LLC. The transaction, which closed in January, will produce as much as $15 million in annual cost savings, SXC said.

Potential acquirers of SXC may also wait until there’s more clarity on how President Barack Obama’s health-care reform law and the coming election will affect the industry, said Les Funtleyder, a New York-based health strategist and portfolio manager at Miller Tabak & Co., which oversees $800 million.

Supreme Court Review

The U.S. Supreme Court yesterday began the first of three days of hearings to determine whether the government can require millions of Americans to obtain health insurance.

“Once we get past the Supreme Court and the presidential election, that may intensify deal making just because it will be easier for companies to carry out long-term strategies, Funtleyder said in a telephone interview.

Still, SXC’s focus on Medicare and Medicaid -- the government programs to provide healthcare for the elderly, disable and poor -- may help a larger rival, O’Neil said. The number of Americans covered by Medicare will likely increase as the population ages, while Medicaid is set to expand under the new health-care regulations, SXC said in a February filing with the Securities and Exchange Commission.

SXC “is a very attractive takeover candidate,” O’Neil said. “They target a number of niche markets that the big guys haven’t targeted traditionally.”

To contact the reporter on this story: Tara Lachapelle in New York at

To contact the editors responsible for this story: Daniel Hauck at; Katherine Snyder at

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