Is Merck Ready For Marty Wygod?Michael Schroeder
Long before Bill and Hillary--before George Bush, even--Martin J. Wygod had drawn a bead on medical-cost containment. As far back as 1987, he was already driving parts of the buttoned-down drug industry to distraction. At the time, Wygod was known vaguely to the business community as a wheeler-dealer, a Mike Milken crony. But for the people who sold prescription drugs, his scrappy game of hardball was starting to make life miserable.
Almost from scratch, Wygod had built Medco Containment Services Inc. into a wildly successful mail-order distributor of discount prescription drugs. He had won so much business from the nation's retail pharmacies that by the summer of 1987 they urged a Senate subcommittee to hold hearings on the safety of his mass-mailing methods. The pharmacists contended Medco had made dangerous errors in filling prescriptions. They even trotted out a former Medco employee who insisted her life had been threatened by zealous managers when she questioned their practices. Outraged, Wygod took the podium and debunked the safety claims as sour grapes. The death threat, it turned out, was utter nonsense. Wygod was convincing; nothing came of the hearings. But the episode underlined his growing image as an industry renegade.
SWORN ENEMY. These days, Marty Wygod is trying to live that image down. He's happy to have his picture taken, but not at either of his two thoroughbred horse-breeding farms. Senate hearings and race horses clash with what the 53-year-old executive appears to want next. Having toppled the status quo in the drug industry, Wygod would like to trade his maverick reputation for a leadership position in the industry's emerging new order.
He took a giant step in that direction on July 28 when drug giant Merck & Co. announced its intention to buy Medco for a staggering $6 billion. The proposed matchup was to the drug industry what the handshake between Yassir Arafat and Yitzhak Rabin was to world politics. If approved by federal regulators--no sure thing--the deal would pair two former enemies. It could also put Wygod in contention to succeed Merck's bookish chairman, P. Roy Vagelos, when Vagelos retires in November, 1994.
The notion of Wygod having a role in running Merck would have raised howls of laughter as little as two years ago. Then, Merck was riding high as one of the nation's most respected companies. As Medco used its huge buying power to wrest big discounts from other drug-makers, Merck wouldn't budge, showing open disdain for Wygod's tactics. But the Clinton Administration's health-cost crusade--coupled with a drought in Merck's new drug pipeline--weakened Vagelos' hand. Suddenly, the idea of courting his enemy began to make sense. "Marty Wygod has distinguished himself as a leader with uncanny vision," says Vagelos.
Wygod remains coy about his intentions. But it's clear the deal would give him enormous leverage in demanding a principal role at Merck. His share in the deal was valued at about $150 million, all of which he'll take in Merck stock and options. That makes him Merck's largest individual shareholder and will give him a board seat. What's more, Medco's other directors would emerge from the deal with more Merck stock than the Merck board. Says health-care consultant Patricia Wilson: "The question is, who bought whom?"
Wygod is currently negotiating his future role, but doesn't deny he wants a major position. "There have been no discussions of title yet," he says. "I'm happy to play whatever role is most productive." Albert M. Weis, a Medco director and a longtime friend, is a little more direct: "Titles have never meant anything to Marty," Weis says. "What he'll want is a lot of responsibility."
Merck officials decline to comment on the situation. But the board is not likely to take the succession issue lightly. Directors include such independent-minded executives as turnaround specialist Lawrence A. Bossidy, chairman of AlliedSignal Inc., and H. Brewster Atwater, CEO of General Mills Inc. Several respected figures from the research community round out the bill. Speculation within the company is that they'll let Vagelos stay on past his retirement date while Wygod gets some subsidiary role. "Roy will want to get the company back on track," says one former top research executive who has kept close ties to Merck.
But Wygod's presence in the wings highlights an identity crisis at Merck that makes anything possible. The board is facing a crucial issue: How should Merck best position itself in a world redefined by the advent of "managed competition?" Wygod is clearly a brilliant strategic thinker and a world-class marketer. "He is the smartest guy in the health-care business today," says Lawrence N. Feinberg, of Oracle Health Investors LP. The board obviously finds those qualities alluring or it wouldn't have agreed to pay 44 times earnings for Medco. The proposed combination is rife with unanswered questions about how the two companies would mesh.
SOAP OPERA? But for all his smarts, Wygod also presents problems. His background as a relentless marketer would definitely clash with the critical side of Merck where expediency comes second to science. The company's research organization--the one that produced Vagelos--has rendered Merck something of a national treasure. "How can the premier high-tech research organization at the same time be the cut-rate marketing king?" asks the former R&D executive. Says another: "It's developing into a soap opera."
A look at Wygod's career highlights the dilemma. While his success is indisputable--he was a multimillionaire before he was 30--he has spent more time buying and selling assets than he has running Medco (table). Close associations with controversial financiers such as raider Victor Posner and Milken enhance that image. And it doesn't help that Wygod's board is stacked with pals who have made millions from generous stock options. Medco, in fact, is currently the target of five shareholder suits alleging the Merck deal was designed to enrich top executives at other shareholders' expense. Medco dismisses the suits as nonsense.
Wygod's roots are firmly planted on Wall Street. He grew up in middle-class Long Island, the son of an independent accountant who had escaped the Nazi threat in Poland before World War II. After graduating with a business degree from New York University in 1961, he headed straight for the brokerage business. He learned the ropes at a firm called Weis & Co. but left in 1966 with the boss's son and a friend to start Wygod, Weis & Florin.
His niche from the beginning was astute research on emerging industries and a precocious talent for takeovers. In the early 1960s, Wygod made millions for clients by recommending an obscure software company called Computer Sciences Corp. In 1968, he helped Posner make his raid on Sharon Steel Corp. The same year, he engineered what was then a record hostile takeover: National General Corp.'s acquisition of insurer Great American Holdings Co. National was so impressed with Wygod that it bought his firm. At 29, he reaped $20 million.
During the next decade, Wygod participated in a number of acquisitions, but spent much of his time focusing on his other real love: thoroughbred horses. He had dabbled in racing ever since Fletcher Jones, the chairman of Computer Sciences, had given him his first two horses in the mid-1960s. He formed River Edge Farm Inc. in 1977, and today the 163-acre spread near Santa Barbara is California's top breeder. Wygod has a second horse farm in New Jersey.
During that time, Wygod also began to see the money-making potential in health care. He and some partners bought a series of companies to form Glasrock Medical Services, which provided home respiratory care. With the help of Crocker Nevin, a Drexel managing director, Wygod sold most of Glasrock to British Oxygen Corp. in 1982 for about $120 million.
RETURNED FAVOR. A year later, he paid Posner $36 million for a mail-order prescription company, National Pharmacies Co. Merging it with a medical-device firm he owned, Wygod created Medco. Much of the early financing came from Fred Carr's First Executive Corp. and from Drexel. Like many Drexel clients, Wygod returned the favor by buying about $250 million of junk bonds. He lost $42 million on the investment but has no regrets. "They lived up to all their obligations," he says.
Personal relationships mean a lot to Wygod. As Medco grew, he filled the board with friends and associates, raising the question: Can a board with such close ties to the CEO be trusted to make independent judgments? Weis and Crocker Nevin are there, as is attorney Thomas R. Ferguson, who represents such Wygod private interests as River Edge Farm. Says Medco marketing chief Wayne T. Gattinella: "Marty is extremely loyal to people who have helped him along the way."
That circle includes Martin J. Raynes, with whom Wygod lost $4 million by investing in New York City real estate. When Raynes' company filed for Chapter 11 in 1991, Medco's board debated whether to ask for his resignation. Wygod, who was best man at Raynes' marriage to the daughter of oil and entertainment tycoon Marvin Davis, opposed ousting him. But he left the decision to the board. Not surprisingly, Raynes stayed.
NO PROBLEM. Another Wygod pal, Lawrence R. Lahr, 37, is president of Wygod's River Edge Development Co. in Ventura County, Calif. Lahr was named to the Medco board in 1988, about the time River Edge started to go sour. The company and other investors owned 181 acres in Ventura County and was the prime developer of Oxnard Town Center, a failed $500 million mall, hotel, and office project. When California real estate tanked, River Edge stopped making revenue bond payments, and officials eventually foreclosed on the land, says James V. Fabian, an Oxnard financial analyst.
Neither Lahr nor Raynes, however, has had much problem making money on Medco's board. Compensation for Medco's directors is paid in stock options, not cash. Some of the options have a split-adjusted strike price as low as 48 per share (Medco's stock is currently trading at around 36). Lahr's current 20,000-share holding would be worth $780,000 if the merger is completed. Raynes's 43,000-share stake would be worth $1.7 million.
The board has been even more generous with Wygod. His contract--a sore point among some shareholders--resembles that of an investment banker. It's filled with perks, generous options, and arrangements to take a percentage of the value of acquisitions. He has been on BUSINESS WEEK's list of the highest-paid executives the past few years, earning $65 million in cash and stock options in 1990-92. But that pales next to his one-time haul from the Merck deal, which includes a $60 million fee, or 1% of the transaction's total value.
Wygod argues that he took only $75,000 in cash compensation during Medco's first seven years and sold no stock as it was growing. "This is my reward for building the company," he says. "Investors have made a lot of money just as executives have." Nevin and other directors admit the close relationships raise questions about appearances. "Could we fire Marty?" jokes Nevin. "I don't know, it never came up." But they insist their stockholdings tie their interests more closely to other shareholders than to Wygod.
Besides, it's hard to argue with Medco's success. When Wygod bought National Pharmacies from Posner, it served just four health-care plans. Now, its 1,450 customers, including General Motors, Aluminum Co. of America, and Georgia-Pacific, insure 33 million patients--26% of all Americans covered by drug benefit plans. Revenues, growing at 37% annually, hit $2.6 billion in the fiscal year ended June 30.
SELLING BLITZ. Wygod's strategy has been simple: cut costs for workers or retirees with chronic medical conditions who require large orders of medicine. Mailing prescriptions directly to retirees slashed retailing overhead. As Medco gained buying clout, it demanded ever larger discounts from drugmakers.
To develop a critical mass, Medco went on a selling blitz. Wygod ordered virtually everyone in the company, not just marketers, to hit the road and sign up health-plan sponsors. Wygod personally landed accounts with the California Public Employees Retirement System and several Blue Cross & Blue Shield plans. He also signed up Occidental Petroleum Corp. after meeting with its late chairman, Armand Hammer.
Medco's aggressiveness has irked competitors from the beginning. It has bought out rivals and lured away their talent. In 1985, Wygod bought PAID Prescriptions, a claims-processing company through which Medco built a valuable data base of physician prescription records. That led to Wygod's most controversial tactic of all: a mail-order plan called Prescriber's Choice.
Prescriber's Choice focuses on nine therapeutic drug categories, including hypertension and ulcers. The strategy is to wring discounts from a manufacturer in exchange for pushing its drug in a particular category. For instance, when Medco receives a prescription for a more expensive brand, a Medco pharmacist calls the doctor to offer a comparable drug at less cost. That's how Medco was able to shift 20% of the market for cholesterol-lowering drugs from Merck's Mevacor to a cheaper alternative from Bristol-Myers Squibb.
Since 1991, though, there have been signals that the giddy growth couldn't be sustained. Seven Medco executives and directors sold over $50 million worth of the stock beginning that November, according to SEC filings. Wygod, who sold $38 million of his holdings, explains that the sell-off was for tax reasons.
Maybe so. But by the summer of 1992, Medco was looking to merge or sell. According to director Weis, Medco had merger discussions with United Healthcare, the big health-maintenance organization. That fell through, but in December, Medco began looking for a drug company to link with. In a move that many interpreted as an attempt to burnish the company's image for sale, Wygod also hired his friend, Richard S. Braddock, soon after Braddock resigned as the highly respected president of Citicorp. Braddock, who now is leaving Medco and is under consideration for the top job at Eastman Kodak Co., will earn more than $35 million for seven months' work.
Medco wanted a stock deal, and considered both Merck and Bristol-Myers. In late May, Wygod started talking to Merck about a strategic alliance, specifically a plan to offer a joint cost-containment program for General Motors Corp. Wygod says the first mention of a possible merger came from Vagelos during a June 28 dinner at Rudolfo's, near Merck's Whitehouse Station (N.J.) headquarters. Vagelos won't comment.
A former research scientist, Vagelos had made it clear that marketing was key to the '90s. Eyebrows were raised in December, 1992, when he officially designated Richard J. Markham--a hard-charging salesman with no research experience--as his heir apparent. When Markham resigned inexplicably in July, many industry watchers speculated that it was because he wanted a Medco deal and Vagelos didn't. But it may have been the other way around. "We developed a real rapport and mutual respect," Wygod says of Vagelos. Markham, who has taken a post as president of Marion Merrell Dow Inc., says he left for personal reasons.
LOCKED IN. Credit Wygod's salesmanship with making Vagelos see the potential of a Merck-Medco alliance. After all, the problems involved in meshing the two companies are enormous. Medco argues that getting rid of redundant marketing operations can save $1 billion a year. Analysts also point out that Wygod has been hoarding $750 million in cash which he invests in securities--a big bonus for any acquirer. But what of Prescriber's Choice? Merck isn't exactly going to demand discounts of itself. Several drugstore chains have threatened to substitute rival drugs for Merck's if the deal goes through.
Merck has locked Wygod in for three years to help smooth things out. What will happen after that remains to be seen. Some industry watchers speculate that if Vagelos does leave, the company might then name a Merck veteran president and CEO, while Wygod would be named chairman. The rationale: The setup would play to Wygod's strengths: strategic planning, finance, and dealmaking, while isolating him from R&D.
Weis, who has known Wygod for 30 years, only worries that his pal might have trouble with Merck's bureaucracy. "Marty was a decision-maker at Medco," he says. "He would tell executives what he wanted and expected them to find a way to do it. The board went along with most of his decisions. We felt he was right." Merck's board is likely to ask a few more questions, but one thing is already clear: Marty Wygod will have a big role in Merck's future, and no matter how hard he tries to restyle his image, he isn't likely to change his stripes.
A MULTIMILLIONAIRE AT 29 1961 Earns business degree from New York University. 1961-65 Hotshot broker/analyst at Weis & Co., Wall Street. 1966 Forms brokerage, Wygod, Weis & Florin, known for astute research on emerging industries and takeovers. Helps Victor Posner nab Sharon Steel Corp. 1968-69 Helps National General's hostile take-over of Great American Holdings Corp. At 29, sells his brokerage to National General Corp. for $20 million. 1970-77 Launches Merchant Investors Inc., a merchant banker. 1977 Buys Glasrock Medical Services, a home-care medical device company. 1982 Sells most of Glasrock to BOC Group PLC for $120 million. 1983 Buys National Pharmacies Inc., a small mail-order drug business, from Posner for $36 million and builds it into Medco. 1993 Agrees to sell Medco to Merck for $6 billion. May pocket more than $150 million. DATA: BUSINESS WEEK