Express Scripts Takes Priority Healthcare

The deal will give a big pharmacy benefit manager a stronger position in the fast-growing specialty drug market.
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Express Scripts

(ESRX)

has chosen a popular formula for growth.

The giant pharmacy benefit manager will pay $1.3 billion in cash for

Priority Healthcare

(PHCC)

, an industry leader in the booming specialty pharmacy business. The deal is expected to essentially double Express Scripts' specialty business into a $2 billion-a-year operation, according to Lehman Brothers analyst Lawrence Marsh.

Currently, Express Scripts generates about $15 billion in revenue companywide.

The Priority acquisition continues a steady stream of consolidation in the industry. Just last year, Express Scripts itself purchased CuraScript in an effort to capitalize on the rapidly growing specialty pharmacy business. More recently, competitor

Medco

(MHS)

this year agreed to cough up $2.2 billion -- paying a 43% premium -- for specialty player

Accredo Health

(ACDO)

.

In comparison, Express Scripts seems to be getting a bargain. The company's $28-a-share offer represents just an 8.3% premium over Priority's most recent closing price.

Both companies celebrated the combination on Friday. Express Scripts said the deal would create "one of the largest and most comprehensive specialty platforms in the industry." Meanwhile, Priority portrayed the acquisition as a good deal for everyone involved.

"All of our customers will benefit from the combined strengths of the two organizations," said Priority CEO Steve Cosier. "This transaction demonstrates our commitment to serving the needs of all our constituents, providing opportunities for our employees and delivering value to our stockholders."

Excluding merger-related expenses, Express Scripts expects Priority to be neutral to earnings in 2005 -- with the deal closing in the fourth quarter -- and boost profits by up to 4 cents a share the following year.

Shares of Express Scripts slipped less than 1% to $47.59 on news of the deal, which will be financed through a combination of cash on hand and bank debt. Priority jumped 6.4% to $27.50 Friday morning.

Extra-Strength Growth

Already, Express Scripts has seen its investment in the specialty space pay off. The company says its CuraScript business has "rapidly grown" since last year's acquisition and, looking ahead, predicts phenomenal expansion for the specialty industry as a whole.

"Specialty pharmaceuticals are the fastest growing component of prescription drug spend," Express Scripts said when announcing the deal late Thursday, "totaling approximately $35 billion in 2004 and expected to exceed $70 billion in 2008."

Express Scripts will now be ready to take advantage of that growth. After the Priority acquisition, UBS analyst Ricky Goldwasser estimates, specialty pharmacy sales will account for some 18% of the company's revenue. In comparison, he says, the specialty business accounts for 13% of revenue at Medco -- even after the Accredo acquisition -- and a much smaller 7.6% at

Caremark

(CMX)

.

"We view this as a positive," writes Goldwasser, who has a neutral rating on the stock, "as specialty business is faster growing compared to base business (15% to 20% versus 3% to 5%) and has higher margins (8% to 10% versus 5% to 7%)."

Marsh offers further specifics. Notably, he says, injectable specialty drugs -- used for chronic diseases such as multiple sclerosis and Hepatitis C -- can cost more than $1,000 per prescription compared with an average price of between $50 and $75 for oral medications.

Logical Mixture

For his part, Marsh calls the Express Scripts deal "a logical further extension of the consolidation of the growing specialty space." Marsh, who has an equal-weight rating on the company's stock, points out that he has now seen four specialty pharmacy acquisitions over the past six months alone.

Despite strong demand for their products, Marsh explains, independent specialty pharmacies have seen their margins erode with the introduction of new industry participants -- including powerful PBMs -- and the maturation of certain product lines. Priority itself has weathered a hit to both profits and gross margins in recent years, he adds.

Goldman Sachs analyst Christopher McFadden believes that environment could help explain why Express Scripts has gotten such a good deal on Priority.

"Tactically, we view the deal (with a modest 8.3% premium to last close and 5.6% premium to PHCC's 52-week high) as a signal by PHCC that a stand-alone specialty pharmacy model ... would be at a competitive disadvantage to integrated PBM/specialty models," wrote McFadden, who has an in-line rating on Express Scripts' stock. Meanwhile, "for ESRX, the deal augments (an) existing specialty platform, although we note ESRX recently reaffirmed they have adequate scale in that segment."

Regardless, that scale is set to broaden. Marsh estimates that Priority will add $1 billion to Express Scripts' specialty revenue and, moreover, bring very little in the way of integration challenges because both of the company's specialty businesses will be based in the same area.

Indeed, Marsh highlights only one potential drawback. The deal, he says, could "debunk" speculation that Express Scripts -- smaller than both Medco and Caremark -- will become a near-term takeover target.

At the moment, however, Express Scripts seems compelled to keep expanding on its own.

"This acquisition strengthens CuraScript's position as one of the leaders in the specialty marketplace and reinforces our business model, which is built around the alignment of interests with clients and patients," CEO George Paz said. "The increase in size and scale strengthens our ability to provide greater affordability of specialty drug therapy."