(Express Scripts, Medco story updated for analyst comment)



) -- The mega-deal between

Express Scripts



Medco Health Solutions


would create the largest pharmacy benefits manager in the United States, but Medco shareholders need to decide if the sudden gain in shares is too good to risk while waiting on regulators to sign off on the deal.

Medco shares rose 19% on Thursday and Friday after news of the deal was released. Yet given that Express Scripts offered to pay a value of $71.36 per Medco share in cash and stock, there's still a hefty merger arbitrage premium left on the table for investors. On Thursday, after Medco shares gained 14%, there was still a spread of 12%. By Friday, when Medco shares rose by another 3% to $65.96, there was still 9% in upside left to reach Express Scripts' bid. Shares were close to flat on Monday.

A typical arb spread on deal uncertainty might leave 5% to 6% on the table. The bigger spread in Medco shares is one sign of the level of

regulatory scrutiny

that the market expects the companies to face. Yet with the market pushing up Medco shares again on Friday, and the management teams of Express Scripts and Medco sounding confident that the deal will be approved, should investors really get out now and leave the 9% upside on the table?

For Anthony Vendetti, health care analyst at Maxim Group, the answer is obvious: Get out of Medco now and get out quick. Vendetti thinks the deal has a 70% chance of passing anti-trust muster, but the analyst still is not willing to take that risk. His reason for playing the Medco gains conservatively stems from his belief about what Medco's business prospects will be if the deal is rejected.

"There really is no turning back for Medco, and it would be a disaster for them if the deal didn't make it. We are telling investors to get out of Medco and be happy you got a reprieve," Vendetti said.

The reprieve is a reference to the fact that Medco announced that it was losing the UnitedHealth pharmacy benefits business on the same day that the acquisition plans were revealed. The combination of the best and worst of times led some analysts to refer to the Express acquisition as Medco's "last gasp."

Newton Juhng, analyst at FBR Capital Markets said that the loss of the UnitedHealth deal will actually help Express Scripts and Medco make the case that their deal does not violate anti-trust laws. UnitedHealth is now going to be a much bigger player in the PBM space and with three large-scale PBM options, the case can be made that there is enough choice.

"The bearish argument is that they will just be too strong and exert their size to set the price in the market, but I don't believe they can dictate price. They may be in a stronger negotiating position, but that's what a PBM does, you try to gain leverage," the FBR Capital Markets analyst said.

Juhng added that he views the UnitedHealth loss as an isolated case because there are only a handful of companies that could even take the PBM business in-house and grow it in scale.

Maxim Group's Vendetti said that Medco is taking the much risk bigger risk, whereas if the deal doesn't go through, Express Scripts will receive only a surface wound. "Express Scripts is willing to take a chance, but Medco is the one taking a bigger risk," the Maxim Group analyst said.

The dire outlook for Medco presented by the Maxim Group analyst, though, was met with resistance by other health care analysts.

Take Brian Lawson, health care associate analyst at RBC Capital. Lawson said he wouldn't disagree with the argument that Medco is taking the bigger risk. If the deal fails, the market sentiment would be that Express Scripts gave it their best shot and still have a core business to run, whereas Medco has business losses that stand out.

He said it's fair to make the case that this deal is the last opportunity to have an attractive exit for Medco shareholders, but RBC Capital remains optimistic about the deal's prospects in regulatory review.

John Kreger, health care analyst at William Blair, said it's a typical response to say "sell now, get your profits now," but he feels the spread being wider than normal on this deal is a reason to hold onto Medco shares. Kreger took the minority opinion that Medco's business would even be defensible if the deal implodes.

"I wouldn't go so far as to say Medco has more risk here," the analyst said. "I understand the logic that the UnitedHealth deal is a symbol of more deals to be lost, but I don't subscribe to that scenario," Kreger said.

Analysts expect the regulatory review to take at least nine months to a year, and this is one more reason why Maxim Group's Vendetti sees doom for Medco if the deal fails. Analysts also noted that the lack of a breakup fee on the deal was notable.

FBR Capital Markets' Juhng said the lack of the breakup fee could be read as one more sign of the deal being a no-lose situation for Express Scripts and Medco's weaker position. "Because there is no termination fee, it is inherently more dangerous to own Medco shares. At the 11th-hour Express Scripts could walk. If Medco had a strong bargaining position, they would have gotten something put in. Express Scripts has a win if the deal goes through, and if doesn't, one of their major competitors is a lot weaker," Juhng said.

The companies said the deal was not about cutting costs during the conference call on Thursday, but Vendetti said that there's no doubt that Medco sales people will see the handwriting on the wall over the next year, and significant job hunting and poaching will take place.

Vendetti also said it's a fine line between a commission-based salesperson doing their job regardless of the longer-term view because they've got to earn, and losing their focus because they think there's a 50% chance of losing their job if an acquisition is approved.

"They are talking about $1 billion in cost synergies and that's a low number. They will say there's room for everyone but that can't be true at the end of the day. The sales force won't double, even if it won't be cut in half. It's somewhere in between," Vendetti explained.

This also translates into an environment where customers of those sales people aren't even so sure about Medco's future viability, and may have concerns about the business being layered in with Express Scripts, a company that certain customers may prefer not to work with.

"My point is that this would be an unmitigated disaster for Medco is this deal falls through, Medco would be a much weaker company by the time the federal government review is finished," Vendetti said.

William Blair's Kreger said losing people and people being poached is part of any big deal. "I think it's fair to say they will lose a lot of people, but not any more than in any other similar deal situation. The big caveat is can the government get comfortable? This is a fairly consolidated industry so it will get a high degree of scrutiny, but I don't think the companies would go this far unless they felt that they could get the deal cleared."

Analysts also noted that Express Scripts has indicated it will do what it takes to get the deal done, meaning that if regulators require divestitures of assets in certain markets to maintain a competitive balance in the sector, Express Scripts won't balk before making a concession.

FBR Capital's Juhng said despite the upside still on the table in Medco shares, and his belief that the companies can ultimately make a convincing case against anti-trust concerns, FBR moved its rating from buy to market perform. He summed up the risks in his downgrade of Medco by stating that remaining upside is for investors that are willing to stomach the speculation risk that is likely to move Medco shares up and down until the transaction gets resolved. "There is a lot of upside because there is so much risk involved," Juhng said.

For Medco shareholders, then, the question is which would be the more bitter pill to swallow: taking the 19% gains already in shares today and missing out on the remaining 9% when the deal closes, or waiting for the rest of the upside, only to see the government nix the deal?

-- Written by Eric Rosenbaum from New York.

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