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Express Scripts, Medco Deal Gets FTC Approval (Update 1)

Updated to reflect Express Scripts, Medco lawyer comments and additional data throughout.

NEW YORK (TheStreet) -- A rapidly changing competitive landscape in the industry to fill prescription drug benefits paved the way for Monday's approval of Express Scripts (ESRX) $29 billion acquisition of Medco Health Solutions (MHS) by the Federal Trade Commission, in what was a hotly contested antitrust review.

In approving the merger by a 3-1 vote, the FTC said that while the tie-up will create an industry powerhouse the the deal was unlikely to raise the cost of prescription drug plans for individuals, companies and government agencies. While investors had anticipated a deal approval, Express Scripts shares continued a 2012 surge on high expectations for potential cost savings as a result of the deal.

"The FTC is not stuck in cement in terms of historical market positions or market shares," says Mike Cowie, a partner at law firm Dechert, which advised Medco Health Solutions on the antitrust review to the deal. Cowie notes that the pharmacy benefits manager industry was facing new competitive threats from UnitedHealth Group (UNH) and Catalyst Health Solutions (CHSI). "When you have an industry undergoing rapid change like this, it shows that it is highly competitive."

In particular analysts targeted the emergence of UnitedHealth as a competitor, after it previously was one of Medco's key customers with a $11 billion contract that represented nearly 20% of the company's sales. Prior to Medco's merger agreement with Express Scripts, UnitedHealth said in June that it would not renew a contract covering 20 million of its pharmacy benefits customers that expires in 2012.

"The emergence of UNH as a major player, the continued presence of several carve-ins, and increasing scale from mid-size players has moved the discussion from a Big 3 paradigm to a landscape with multiple distinct competitive PBM models," wrote Credit Suisse analyst Glen Santangelo in a Monday note to clients

The deal will combine two of the three leading pharmacy benefits managers, creating the industry's largest player with nearly $100 billion in revenue and a 40% market share.

In its approval the FTC noted the impact of healthcare reform, the entrance of health plans into the PBM market and the success of smaller competitors as reasons that the top three industry players, who control a large majority of the PBM market, don't have pricing or competitive market control. "[A] number of health insurers have made substantial investments and renewed their efforts to expand their PBM offerings, spurred by the passage of healthcare reform and the creation and implementation of Medicare Part D," noted the FTC. Those plans include UnitedHealth, Humana (HUM), Aetna (AET) and Cigna (CIG), according to the FTC's review.

The FTC also highlighted smaller players like CatalystRx and SXC Health Solutions (SXCI) as smaller competitors with "recent success winning significant employer business, including large employer accounts."

After Monday's deal approval by the FTC, analysts expressed increasing optimism about the possible cost savings and earnings growth that Medco will add to Express Scripts. "This is another transformative acquisition that roughly doubles the size of the company & offers clear synergies as we move through the peak of the generic wave," added Glen Santangelo, who re-instated coverage on Express Scripts with an "outperform" rating and a $68 a share price target.

While Express Scripts management has said that the deal will lead to $1 billion in annual cost savings, expectations are that the St. Louis- based company may see far greater synergies, providing an added earnings per share benefit. "Management's guidance of about $1 billion in cost savings seems conservative to us," wrote Robert Willoughby of bank of America Merrill Lynch, who rates shares a "buy" with a $67 price target. He expects additional savings to help share buybacks or the paydown of the company's debt.

Prior to Monday's FTC ruling, Medco's stock was just below the $71.36 a share purchase price agreed in July, signaling investor increasing investor confidence over the deal approval. On news of the approval, Express Scripts shares rose nearly 3% to $55.68. The company's shares have gained nearly 25% year-to-date on increasing optimism about a closure to the Medco merger.

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After the merger was first announced in July, antitrust inquiries led by Congressional leaders and a second review by the FTC caused Medco's shares to drop below $50, over 30% below the offer price on concerns of an antitrust blockage.

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