Medco to Acquire Research Firm - Analyst Blog

Medco Health Solutions (MHS), a leading health pharmacy benefit management (PBM) company in the US, entered into an agreement to acquire privately-held United BioSource Corporation for $730 million. The transaction, subject to regulatory approvals, is expected to close during the third quarter of 2010. Excluding one-time items and amortization, this acquisition is expected to be slightly accretive in 2011.

United BioSource caters to pharmaceutical and biotechnology companies and guides them regarding safety, effectiveness and affordable use of medicines. The company also conducts several studies for its clients, which include risk evaluation and mitigation studies (REMS), cost-benefit and cost-effectiveness evaluations and budget-impact modeling, among others. United BioSource is expected to generate revenues of $280 million with an annual growth rate of over 20%.

The healthcare reform is targeted to improve quality and reduce costs so that more people gain access to medical benefits. In this scenario, the decision to acquire United BioSource is meaningful since this will enable Medco to ensure effective use of medicines. 

The transaction is expected to be financed by Medco from its free cash balance and existing debt. At the end of the second quarter of 2010, the company had $1.2 billion in cash and cash equivalents and $4 billion of debt.

Our Recommendation

An aging population coupled with the higher incidence of chronic diseases continues to drive demand and add to the escalating cost of new drug therapies. As a result, we expect the outlook for the PBM industry to remain positive. MHS, being the nation’s largest mail-order pharmacy operation, is therefore well positioned to benefit from both favorable demographic trends and increasing acceptance of more efficient mail order and Internet-related distribution channels.

Moreover, the development of generic versions of branded pharmaceuticals and the rise in generic substitution are positive for earnings growth. Generic substitution for drugs is a significant factor in the reduction of prescription healthcare costs. Generic drug usage, as a percentage of total prescriptions, is increasing. This is likely to increase further as patents of several key branded pharmaceutical products expire over the next 5 years and pressure mounts from sponsors on physicians to shift patients to less expensive generics.

However, the industry is highly regulated at both the federal and state levels. Moreover, though Medco is a leading player in the PBM segment, it faces tough competition from many established players.

Based on the long-term potential of the company, we maintain our Neutral rating on the stock, which also corresponds to the Zacks #3 Rank (short-term 'Hold' recommendation).