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The engagement announcement Tuesday night of two pharmacy benefit management giants sent one company's stock soaring and the other company's stock sinking on Wednesday.

The buyer is

Caremark Rx

(CMX)

, of Nashville, Tenn., which said it would pay about $6 billion in stock, cash and assumed debt for

AdvancePCS

(ADVP)

, of Irving, Texas.

If consummated, the marriage would continue the consolidation of this medical services industry in which three companies would account for more than half of the market. Pharmacy benefit managers provide an assortment of services to employers and insurers to purchase drugs, conduct disease management programs, enact cost containment practice and provide mail-order products.

Shares of Caremark Rx fell Wednesday, dropping 8.3%, or $2.10, to close at $23.30. The stock fell as low as $22.14. In contrast, shares of AdvancePCS jumped 18.6%, or $7.45, to close at $47.45. The stock rose as high as $48.83.

Analysts placed the total deal at $54 to $54.61 per share.

The two companies "are a compelling strategic fit with relatively little market overlap," said Mac Crawford, chairman and CEO of Caremark Rx, who will assume the same titles at the new company.

The transaction got a preliminary nod from Standard & Poor's, which placed Caremark Rx on its credit watch list with "positive implications."

"The two businesses appear complementary," S&P said. Caremark Rx's strengths are corporate clients, mail-order drugs and the distribution of specialty pharmaceuticals. AdvancePCS is stronger in the managed care market. S&P officials will meet with company executives before elaborating on the credit watch listing.

AdvancePCS shareholders will receive the equivalent of 2.15 shares of Caremark Rx stock for each AdvancePCS share. The payment would be 90% stock and 10% cash; Caremark Rx shareholders would hold 58% of the new company even though it had revenue of $7.93 billion for the 12 months ended June 30 and AdvancePCS had revenue of $14.68 billion.

Caremark Rx's earnings per share were 93 cents during this period. AdvancePCS had $1.87 earnings per share, but it also has almost three times as many common shares outstanding as does Caremark Rx.

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The deal, approved by the companies' directors, must be endorsed by shareholders and regulatory agencies.

Antitrust Attention

Wall Street analysts are divided over how much federal antitrust attention will be directed at the transaction. If the deal succeeds, the new company would join

Medco Health Solutions

(MHS)

and

Express Scripts

(ESRX)

in dominating the industry. By certain measurements, the new company would be the market leader.

"We believe this transaction may face material regulatory scrutiny," said John Szabo, of CIBC World Markets, in a research note to clients on Wednesday. "We would note that the

Federal Trade Commission has been taking a closer look at health care generally in recent months."

Szabo cut his rating on AdvancePCS to sector performer from sector outperform, because the company's stock had jumped into the neighborhood of his $47-a-share price target and because "considerable regulatory risks" will affect completion of the transaction. He doesn't own shares; but CIBC is a market maker in the stock, and the firm expects to receive or intends to seek compensation for investment banking services from AdvancePCS in the next three months.

But Kevin Berg, of Credit Suisse First Boston, told clients Wednesday that he doubts the FTC or any other federal agency will raise antitrust concerns. On the basis of the number of prescriptions filled, which Berg says is the most "relevant" measurement, Caremark Rx had 4.6% of U.S. pharmacy prescriptions for the first half of 2003, while AdvancePCS had 15.3%. Medco had 19.3%, and Express Scripts had 13.5%. A successful deal would make the new Caremark Rx the market leader -- but not by an overwhelming margin.

"The deal could cause a domino effect in that Medco Health and Express Scripts could now accelerate a search for larger specialty businesses," said Berg, in a Wednesday research report in which he maintained an outperform rating on Caremark Rx and said his outperform rating for AdvancePCS is "under review." Berg doesn't own shares of either company. His firm makes a market in the stock of Caremark Rx, and the firm expects to receive or seek investment-banking related compensation from Caremark Rx in the next three months.

"We do not anticipate competitive bids or antitrust issues," added Christopher McFadden, of Goldman Sachs, in a report to clients Wednesday. He retained his "outperform" rating on Caremark Rx, saying the deal "looks smart" even at the 36% premium that Caremark was offering over AdvancePCS' Tuesday closing price. He rates AdvancePCS as in-line. He doesn't own shares in either company; his firm expects to receive or seek compensation for investment banking services from both companies in the next three months.

McFadden said the willingness of Advance PCS management to "step aside" -- Caremark Rx executives will hold the chairman, chief executive, president and chief financial officer titles -- suggests that this is a friendly and simple deal.

McFadden looks at the pharmacy benefit management market share from the perspective of adjusted medical claims. Using that measurement, the new company would have a 25% market share -- 19.3% from AdvancePCS and 5.7% from Caremark Rx -- while Medco would have 24% and Express Scripts would have 17.1%.

Although analysts calculate market share in different ways, they agree that this deal will put the squeeze on Express Scripts to bulk up via acquisitions. Express Scripts' stock dropped 6.2%, or $4.02, to close at $60.72. Shares of Medco gained 3.2%, or 83 cents, to $26.83.

Independent Settings

The proposed AdvancePCS-Caremark Rx deal also illustrates that pharmacy benefit management services appear to work best in independent settings rather than as elements of large drug companies. Each of the major players in today's market has had some contact with a large drug company, and each venture has been unsuccessful or disappointing.

For example, Medco was recently spun off by Merck 10 years after the drug giant acquired it.

AdvancePCs has a more complicated history. One predecessor company -- PCS Health Systems -- was launched in 1969 and was later acquired by McKesson Corp. which, in 1994, sold it to Eli Lilly.

Lilly held the company for five years, selling it to Rite Aid, which, after one year, sold it to Advance Paradigm Systems, a 16-year-old pharmacy benefit management firm that had been growing rapidly via acquisitions of smaller firms. The combined company was called AdvancePCS.

Merck and Lilly weren't the only big drug companies that thought they could benefit from their own pharmacy benefit management operation. The old SmithKline Beecham got into the act in 1994, buying Diversified Pharmaceutical Services from United HealthCare. Five years later, it sold the pharmacy benefit management firm to Express Scripts.

And Caremark Rx traces part of its heritage to Richard Scrushy, the former chief executive of the hospital company HealthSouth. (

Click here for a related article.) Scrushy founded MedPartners in 1993, which grew through a series of acquisitions and mergers -- the most notable being Caremark, which started in 1985 as a division of what is now Baxter International. Caremark was spun off from Baxter in 1992 and was acquired by MedPartners in 1996. The combined company was later renamed Caremark Rx.