CHSI Catalyst Health Solutions, (MM)

On Wednesday, Catalyst Health Solutions Inc. (CHSI) announced that it has entered into a $4.4 billion takeover agreement with rival pharmacy benefits management (PBM) company, SXC Health Solutions Corp. (SXCI). As per the agreement, SXC Health will acquire Catalyst Health for $28 per share in cash and 0.6606 shares of SXC Health in exchange of every share of Catalyst Health.

Considering the closing share price of the two companies on April 17, 2012, the agreement terms translate into a purchase price of $81.02 per share of Catalyst Health, representing a 28% premium on Catalyst’s closing price of $63.54 on April 17. Following the acquisition, the shareholders of SXC Health and Catalyst Health will own 65% and 35% of the combined company, respectively.

The takeover is expected to be completed by the second half of this year, subject to the approval of U.S. anti-trust authorities and shareholders of Catalyst Health and SXC Health as well as other customary closing conditions.

JP Morgan Chase & Co. (JPM) is set to finance the cash portion of the purchase consideration for SXC Health. JP Morgan also acted as the company’s financial advisor for the deal along with Barclays Plc (BCS), while Goldman Sachs Group Inc. (GS) and Citigroup Inc. (C) were the financial advisors for Catalyst Health. Meanwhile, Sidley Austin and Milbank, Tweed, Hadley & McCloy acted as the legal advisors for SXC Health and Catalyst Health, respectively.

The deal is expected to be accretive to SXC Health’s earnings from 2013. The benefits of economies of scale and improved operating leverage, arising from the takeover, are expected to generate operating cost synergies of $125 million annually for SXC Health in the first 1.5-2 years after the acquisition. Moreover, the deal is expected to drive the annual revenues of the company to $13 billion.

However, SXC Health will have to bear transition costs of $40–$45 million, while amortization costs related to the takeover will amount to $200 million for the first year after the acquisition. Additionally, SXC Health will borrow $1.7 billion to finance the takeover and this will increase the company’s annual interest expense to about $70 million.

Nevertheless, the combined company is expected to generate enough cash to repay its debt obligations and invest in various growth initiatives, despite incurring increased expenses.

The acquisition will increase SXC Health’ operations substantially, thereby placing it in the same league as the three largest PBM companies – Express Scripts Holding Co. (ESRX), CVS Caremark Corporation (CVS) and UnitedHealth Group Inc. (UNH). The membership base of SXC Health is expected to grow to 25 million following the merger, while the annual prescription volume is expected to surge to over 200 million, making it the second largest independent PBM company in the U.S. in terms of prescription volume.

The merger will help the two companies to retain their competitive advantage in the rapidly consolidating PBM industry, which is leading to intense price competition. Just two weeks ago, Express Scripts acquired Medco Health Solutions for $29 million and emerged as the largest player in the industry, with almost one-third share of the total prescription volume.

However, when the news of the proposed takeover broke, Catalyst Health came under fire with a number of investigations leveled against it. Law firms Rigrodsky & Long, P.A., Block & Leviton LLP, Harwood Feffer LLP, The Briscoe Law Firm PLLC, Powers Taylor LLP, Brower Piven, Levi & Korsinsky LLP, Weiss & Lurie, Robbins Umeda LLP, Faruqi & Faruqi LLP and Glancy Binkow & Goldberg LLP announced investigations against the Board of the company to determine whether it performed its fiduciary duty by ensuring the best possible pricing for the company, as they consider the premium low.

The law firms are concerned that the Board might have failed to maximize shareholders’ value by under-pricing the deal. The concerns cropped up following the news that two directors of the company will join the Board of SXC Health after the merger.

Nevertheless, the integration of the two companies is expected to be smooth as Catalyst Health already uses SXC Health’s claims processing technology. Moreover, SXC Health shares Catalyst Health’s customer-centered approach as well as commitment to lowering healthcare costs without compromising on the quality.

The clients of Catalyst Health will benefit from the takeover as they will be able to reap the benefits of SXC Health’s expertise in PBM as well as its industry-leading technology. They will also have access to a wider product portfolio. SXC Health’s current headquarters in Lisle, Illinois will be the headquarters of the merged entity and the company’s current CEO will act as the CEO of the merged entity.

Currently, Catalyst Health holds a Zacks #3 Rank, implying a short-term Hold rating, while SXC Health carries a Zacks #2 Rank, which translated into a short-term Buy rating. We maintain our long-term Neutral recommendation on Catalyst Health.

 
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