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Traders bet on regulator approval for Medco takeover

Posted 1/4/12

NEW YORK - Even as U.S. regulators take a tougher stance on takeovers, traders are convinced they can reap the biggest return in America by betting Express Scripts Inc. will win antitrust approval to buy Medco Health Solutions Inc.

Medco climbed to within $9 of Express Scripts’ cash-and-stock agreement valued at $66.88 a share yesterday, approaching the closest to the offer price since it was announced on July 21, according to data compiled by Bloomberg. While AT&T Inc.’s deal for T-Mobile USA collapsed last month after the Justice Department sued to block it, shares of both Medco and Express Scripts have rallied, signaling that arbitragers can still reap a 15 percent profit betting the transaction will close.

The attempt to create the largest U.S. manager of prescription drug benefits can withstand scrutiny from the U.S. Federal Trade Commission because the combination will have more leverage to negotiate lower prices for consumers, according to Tullett Prebon Plc. Unlike AT&T’s failed bid, which would have given the two biggest U.S. mobile-phone carriers 70 percent of the market, Express Scripts’ purchase of Medco still leaves rivals managing plans for seven of every 10 insured Americans.

“The return is clearly off the charts,” Bill Kavaler, a New York-based special situations analyst at Oscar Gruss & Son Inc., said in a telephone interview. Express Scripts and Medco are “making a very strong argument that between cost savings, or the savings that will get passed on to customers, and their ability to negotiate with the pharmaceutical manufacturers -- this is good for the country,” he said.

Acquisition Detail

Lowell Weiner, a spokesman for Medco, said that the Franklin Lakes, N.J.-based company continues to “expect the transaction will close during the first half of this year.”

Brian Henry, a spokesman for St. Louis-based Express Scripts, said in an e-mail the company also anticipates the deal will be completed in the first half of 2012.

Mitchell Katz, a spokesman at the Washington-based FTC, said the commission doesn’t comment on ongoing investigations.

In July, Express Scripts agreed to pay Medco holders $28.80 a share in cash and 0.81 Express Scripts share for each Medco share held, the companies said in their statement at the time.

Including net debt, the acquisition was valued at $34.3 billion, exceeding the $21.7 billion deal that formed CVS Caremark Corp. in 2007 as the largest in the industry, according to data compiled by Bloomberg.

At yesterday’s price of $58.03 a share, Medco traded at a discount of $8.85 to the offer price.

Arbitrage Spread

Without taking into account when the deal will close, the difference on a percentage basis is currently the widest of any billion-dollar deal in the U.S., indicating the acquisition offers the biggest arbitrage profit among comparable takeovers.

If the transaction is completed by the end of June, as both companies project, traders betting on the takeover stand to make at least a 31 percent return on an annualized basis, according to data compiled by Bloomberg.

“I definitely think it’s an opportunity for investors,” Jon Green, an analyst at Murphy & Durieu LP in New York, said in a telephone interview.

While the deal spread has narrowed from as much as $15.44 a share, Medco is still trading below the offer on concern among some investors that regulators will block or delay the takeover.

Two trade groups -- the National Community Pharmacists Association and the National Association of Chain Drug Stores -- opposed the deal in a Senate hearing last month, saying the merged company would reduce consumer choice and steer patients to its own mail-order prescription services.

‘Political Football’

“The regulatory environment on this one has become quite heightened,” Will Harrington, a New York-based merger arbitrage analyst at Wall Street Access, said in a telephone interview. “It’s become almost a political football.”

Increased antitrust scrutiny from U.S. regulators has already scuttled two of 2011’s biggest proposed acquisitions.

Dallas-based AT&T, the largest U.S. telephone company, said last month it was ending the $39 billion deal for T-Mobile USA following a lawsuit from the Justice Department and opposition from the Federal Communications Commission.

Nasdaq OMX Group Inc. dropped its $11.3 billion hostile bid for NYSE Euronext in May after the Justice Department, citing concerns about the potential for monopolies in combining the New York-based exchanges, indicated it would block the proposal.

Oscar Gruss’ Kavaler says that Express Scripts’ bid for Medco doesn’t present the same level of antitrust concern as AT&T’s failed takeover of T-Mobile USA because the prescription- benefits management industry is more vulnerable to new entrants and existing rivals still provide enough competition to counter the increased market share.

‘Tooth and Nail’

Together, Express Scripts and Medco will have less than a 30 percent share among companies that handle drug benefits for corporate and government clients, George Paz, Express Scripts’ CEO, said in Senate testimony last month.

While AT&T’s deal for T-Mobile USA failed over concern that combining the second- and fourth-largest U.S. mobile-phone companies could result in higher prices for consumers, Express Scripts and Medco can probably convince regulators they will cut health-care costs by negotiating with pharmaceuticals companies to drive down drug expenses, said Sachin Shah, a Jersey City, New Jersey-based merger arbitrage strategist at Tullett Prebon.

“The FTC cares about customers, but this isn’t going to hurt customers -- it’s a net benefit to customers,” he said in an interview. “They’re going to be bigger, but not a juggernaut that can push people around. They’ll still have to fight tooth and nail.”

Public Interest

The health-care industry is also under increased pressure to reduce medical expenses after a debt-ceiling agreement in August required cuts on Medicare, the federal health program for the elderly and disabled. That may create more demand from the government for larger benefits managers that can win the biggest price reductions for prescription drugs, Shah said.

“The merits of the transaction make sense with regard to potential public benefits,” Roy Behren, who co-manages the $5 billion Merger Fund at Westchester Capital Management Inc. in Valhalla, New York, said in a telephone interview. The fund owned Medco shares as of the end of September, based on its latest regulatory filing. “We think that there’s a greater than market-implied chance that the deal is successfully completed.”

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