| You Decide | FIN 561-60619 | Mergers and Acquisitions, Week 3Professor Gene Smith, PhD | Melissa Walter | 7/27/2014 |

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Abstract Merck & Company (Merck) is evaluating the possible acquisition of Medco Containment Services Incorporated (Medco). The Chief Operating Officer, Executive Vice President of Sales and Marketing, and the Chief Financial Officer have all stated their thoughts and concerns regarding this matter. It is my job to make the final recommendation to the Board of Trustees.

Executive Summary Merck is a leading pharmaceutical manufacturer and Medco is a leading pharmacy benefits manager. Both companies have a strong hold on their piece of the market. In 1992, Merck had revenue of $9.7 billion while Medco recorded $2.2 in revenue.4 Benefits of the merger include: * Increased marketing potential through Medco’s accumulated data * Access into the Managed Care market * Decreased costs in sales and marketing efforts
Risks include: * Merging of corporate cultures * Loss of R&D dollars due to subsidizing Medco * Regulatory and compliance threats.
The stated price for the merger is $6.6 Billion. At the time of the merger, I would have recommended to the Board to proceed with the merger as benefits seem to out-weigh the risks. However, in looking back, due to the FTC findings stating the merger did create an unfair advantage to Merck, I would have to re-evaluate. Merck was unable to issue the intended Medco IPO which had a planned offer price of $20 to $22 per share. In 2003 announced its plan to spin off Medco to existing Merck shareholders for .1206 shares of Medco stock for every share of Merck stock held. Expensive litigations and poor stock prices equal an unhappy state for investors.

Analysis
History of Merck and Medco Before we can make a recommendation to or not to merge Merck and Medco, it is important to understand the history of each individual company. Merck’s beginning was created in 1668 when Friedrich Jacob Merck purchased an apothecary in Darmstadt, Germany, called ‘At the Sign of the Angel’. In 1827, Heinrich Emmanuel Merck converted the pharmacy into a drug manufactory producing morphine, codeine, and cocaine. The company became known as E. Merck AG. Entry into the United States came in 1887 when Theodore Weicker opened the first sales office. Weicker was joined by George Merck in 1891; and in 1899 the two acquired a 150-acre plant site in Rahway, New Jersey. This location was the company headquarters and also housed the research laboratories and chemical production facilities until the 1990’s.1 During the 1900’s a series of important events occurred allowing Merck to become a leader in the pharmaceutical industry. One of these events was the merger with Powers-Weghtman-Rosengarten, a pharmaceutical firm in 1927. It was after this merger that George W. Merck incorporated the company as Merck & Co., Inc. The other important merger was that of Sharp & Dohme, Incorporated in 1953. This merger allowed Merck to expand its distribution network and gain new customers.1 Important drugs were also created during this time period. The discovery of vitamin B12 was the first. Cortisone and streptomycin, an antibiotic used for tuberculosis and other infections followed. Vasotec was introduced in 1985 and was used to treat congestive heart failure. It was Merck’s first billion-dollar-a-year drug. In 1992 Merck introduced a cholesterol-fighting drug called Zocor. Zorcor was responsible for over $1 billion in annual sales revenue and became one of the most successful drugs in history.1 Medco Containment Services, Inc. began in 1983 as a holding company created by Martin Wygod. Wygod had previously been involved in investment banking and acquisitions when he set out for new venture. He created the holding company so he could purchase a small vitamin distributor and mail-order prescription drug business called National Pharmacies. He quickly eliminated the vitamin division and focused on building up the mail-order program by selling its services to larger corporations, labor unions, and health plans. By 1992 Medco had over 1,300 company accounts including Alcoa, General Motors, Georgia-Pacific, and Commonwealth Edison Co. and over 6,000 employees. It controlled over 50% of the prescription mail business nationally. Its primary focus was on maintenance drugs for high blood pressure, arthritis, diabetes, and other chronic illnesses.2 In 1984 the holding company went public and changed their name to Medco Containment Services Inc. In 1985 Medco purchased Paid Prescriptions from Computer Sciences Corp. This purchase was important for two reasons. First it allowed plan subscribers to purchase drugs at 40,000 drugstores or through the mail at a discount. Second, it allowed Medco to gather information on consumer drug spending and sell the information to health plan sponsors.2 In 1990 Medco introduced its Prescriber’s Choice program in which drug companies offered deep discounts in return for large volumes sold. It worked as such: a prescription would come into the pharmacy and the pharmacist would notice a cheaper alternative was available. The pharmacist would contact the physician and ask if he/she would like to substitute the cheaper drug as a cost benefit to the patient. Physicians would usually do so, which in turn would lead to more prescriptions for the cheaper drug going to the pharmacy. Medco created Medical Marketing Group Inc. in 1991. Its sole purpose was to collect prescription drug data from drugstores and physicians and then sell the data to drug companies for use in drug promotions and marketing. Also in 1991, Medco acquired American Biodyne, Inc., a provider of mental health services and Personal Performance Consultants which provided employee assistance programs.2 By 1993 Medco had contracts with all but a handful of U.S. pharmaceutical firms. With their strong market hold, they were able to offer medications at 25% less than retail pharmacies. Revenue in 1991 was $1.81 billion and by 1992 it was over $2 billion.2 “Medco has about 33 million customers in the United States and manages 95 million prescriptions a year for government, unions, insurance firms and companies.”4

Strengths and Opportunities: Both companies are leaders in their operations; each possessing a strong hold on the market. IT integration would create synergy in operations and in marketing. Synergy as defined by dictionary.com is “the interaction of elements that when combined produce a total effect that is greater than the sum of the individual elements, contributions, etc.”3 This integration gives Merck access to an enormous amount of data regarding prescription usage and pricing information from Merck’s competitors. Merck would have access to what prescriptions are not being refilled, creating marketing opportunities. Merck would also be able to see the prescribing patterns of physicians and therefore target those who do not routinely prescribe Merck products when one is available. This would increase sales and increase Merck’s market share. The two companies might also be able to consolidate their sales and marketing forces. Previously both parties were meeting with the physicians. This would not be needed if the companies merge. In addition, Medco’s access to the Managed Care market provides new opportunities for Merck. In conclusion, profit margins for the combined company should increase due to an expanded market opportunities and decreased sales and marketing efforts.

Weaknesses and Threats:
Although the reasons to merge the two companies do create benefit, there are some concerns the board should acknowledge. The first being combining the corporate cultures, as our COO notes. As noted in the Associate Press, Medco shareholders are not in agreement with the decision to merge. In fact, they sued to block the deal.5 Combining corporate cultures in any merger is difficult to do. This merger should be a little easier due to both companies being in the healthcare industry. However, constant, timely, and direct communication between the two organizations will be vital.
The second risk is that of reducing research and development dollars Merck has come to expect to subsidize the discounting of Medco’s contract negotiations. Merck is a high profit business; Medco is not. Merck’s existence depends on being a leader in drug creation and innovation. This requires a lot of R&D time and money.
Lastly, legal risks are important to note. As noted earlier, Medco shareholders have sued to block the deal. The possible merger is also being investigated by the F.T.C due to a request from a group of independent pharmacies in New Jersey. They argue the “merger would create a monopoly in the distribution and sale of patented drugs.”6 Due to the sensitive nature of the merger, reporting and compliance measures are bound to follow; therefore increasing administrative costs.

Marketing and Distribution As stated earlier, the merger would create efficiencies in marketing and distribution due to an integrated IT system.

Financial Issues
Our CFO is concerned about the purchase price of $6.6 Billion. As evidenced below, EPS is shown as slightly decreasing after the companies merge.

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Stock prices are did drop after the announcement of the merger, however they recovered nicely by December 1993.
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Regulatory Risks The possibility of this merger has created regulatory risks to Merck as mentioned earlier. If this deal were to happen, it would change the way pharmaceutical manufacturers and pharmacy benefit managers would coincide. Threats of collusion, price fixing, and reduced competition in the market leading to higher drug prices and reduced quality are all items of concern.9

Conclusion Based on the information pertaining to the time period leading up to the merger, I would recommend to the Board of Trustees that Merck proceed with the Medco merger. Future expected profits are expected to out-weigh the risks. However, looking back and applying information since the merger occurred, I might have a different opinion. Litigation proved costly to Merck due to the FTC’s findings of reduced competition due to the merger.9 In addition, Merck was unable to issue the IPO for Medco due to sluggish IPO results. Instead, Merck shareholders were given .1206 shares of Medco for every share of Merck they held.10 The only advantage to the Merck shareholders was the stock price jumped slightly after the announcement was made.

BIBLIOGRAPHY 1) Merck & Co., Inc. History, From Funding Universe Dot Com, July 2012 2) http://www.fundinguniverse.com/company-histories/medco-containment-services-inc-history/ Medco Containment Services, Inc. History

3) http://dictionary.reference.com/browse/synergy?s=t 4) Merck Will Buy Major Manager of Drug Benefits It Will Acquire Medoc Containment for $6 Billion. Medco’s Mission Is To Hold Down Drug Prices, July 29, 1993, Uhlman, Marian, Inquirer

5) http://www.apnewsarchive.com/1993/Merck-Completes-$6-Billion-Merger-With-Medco/id-4c927c19d591bcb785f2bbc53336e44d Merck Completes $6 Billion Merger With Medco, Johnson, Linda, November 18, 1993

6) Company News; Regulators Question Merck’s Buyout of Medco, The New York Times, September 04, 1993

7) http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=262085-1477-27278&type=sect&TabIndex=2&companyid=8304&ppu=%252fdefault.aspx%253fcik%253d310158; Securities and Exchange Commission Form 8-K/A, November 18, 1993, Merck & Co., Inc.

8) http://finance.yahoo.com/q/hp?s=MRK&a=00&b=2&c=1993&d=06&e=28&f=2014&g=m&z=66&y=132

9) Federal Trade Commission, August 27, 1998

10) http://www.merck.com/investors/MRKMedco_Shareholders_letter.pdf Important U.S. Federal Income Tax Information Concerning the Medco Health Solutions, Inc. Stock Distribution