And The Next Juicy Plum May Be...Mc Kesson?

Now that the drama over who will win Paramount Communications Inc. is finally settled, the takeover game may be moving to a new playing field. And the next football could be McKesson Corp.

McKesson? Sure, the huge drug wholesaler and distributor has long had a snoozy reputation on Wall Street and wears none of the glitter of Paramount. But stock traders are busy bidding up McKesson shares in the belief that big drugmakers are sizing it up for a takeover (chart). If they're right, a clash of egos and a juicy bidding war is in the offing.

What's arousing interest in McKesson is not distribution, which accounts for 95% of its $12 billion in sales, but a mouse of a division called PCS Health Systems Inc., with revenues of just $170 million. A mouse, yes, but a mighty one: That 2% of sales will produce a roaring 20% of McKesson's $272 million in operating profit for the year ending in March. PCS's sales and earnings are exploding at 50% a year. And profit margins are some 30%, analysts say.

HEAVY PRESSURE. Indeed, PCS is the leading company in the white-hot new business of managing pharmaceutical costs for big health-plan sponsors, including corporations, governments, and insurance companies. Its biggest competitor is Medco Containment, which Merck & Co. bought for $6 billion in November, 1993--in part to assure a high-volume customer channel for its products, many of which are under extreme price pressure from generic drugs, me-too equivalents, and health-care sponsors trying to force prices down.

Since the Medco deal was announced last July, McKesson stock has steadily climbed from 46 to 65, on the theory that another big drugmaker would seek its own customer-channel advantage by buying McKesson and PCS. Indeed, Wall Street is alive with rumors that everyone from Glaxo to Pfizer to Eli Lilly is circling McKesson.

Is McKesson interested? CEO Alan J. Seelenfreund says he sees no advantage in forging an equity partnership with any drugmaker: "Why would we?" But on questions of takeover, he is circumspect. "I'm only one person," he says. "We have a board of directors" to deal with matters of "corporate governance."

Analysts say that McKesson is trading below its breakup value--not because of any mismanagement but because PCS has become so hot relative to the thin-margin distribution business. Lawrence C. Marsh of Wheat First Securities says McKesson could easily be split. Its bottled-water division and its majority stake in Armor All, a plastic protectant, could be sold. Distribution could also be spun off.

Marsh pegs breakup value at $90 a share, with PCS alone accounting for $50, based on Medco's purchase price. And that figure assumes no emotional bidding war, which could jack the price up further. The Merck-Medco deal has infused pharmaceutical executives with "fear and concern," says Marsh. "A lot of these guys are desperate."

The main way that pharmaceutical-benefit managers are able to influence drug purchasing is through "formularies," or lists of approved drugs based on cost-benefit analysis. Assuming equivalent effectiveness in a group of competing drugs, a drugmaker that controls a formulary can price its product to move to the top of the list, then try to make up in volume what it's giving up in price.

GETTING HOSED? Of course, such an arrangement raises questions of conflict of interest. In fact, PCS uses just this point to market its service against Medco. Currently, big buyers of medicines rely on competition to keep everyone honest, says Dolores G. Mitchell, executive director of the Group Insurance Commission of Massachusetts, who oversees drug-benefit contracts for 160,000 state employees, retirees, and dependents. "If we get hosed, the [contractor] is history," she says. But if a drug company buys McKesson, the biggest independent alternative goes away.

McKesson, meanwhile, is busy building its PCS business. It aims to go beyond pharmaceutical management and become a full-fledged medical-services-management company. In January, it bought an interest in Integrated Medical Systems Inc., an electronic network that links doctors with hospitals and medical laboratories. McKesson will use the system to tie doctors into its pharmaceutical computer network, which is installed in 95% of

the nation's pharmacies. McKesson has also recently bought a stake in Technology Assessment Group, which specializes in "outcomes research," a fast-growing business that evaluates the efficacy of drugs and other medical treatment.

Seelenfreund, CEO for four years and largely responsible for McKesson's current strategy, sees these businesses as the company's future. It remains to be seen whether that company will still be McKesson.