Pharmacy Merger Sparks Fantasy On Wall Street

Apr.19.12 | About: Catalyst Health (CHSI)

Shares of Catalyst Health Solutions (CHSI) rose an incredible 34% Wednesday after competitor SXC Health Solutions (SXC) enters into a merger agreement (read takeover) of the company.

The deal

Under the proposed merger agreement shareholders of Catalyst Health Solutions will receive $28 in cash and 0.6606 in SXC Health Solutions stock for every share they own. This values Catalyst' shares at approximately $80.60, a 27% premium compared to yesterday's close.

The transaction is expected to close in the second half of 2012. Shareholders of SXC Health Solutions will hold roughly 65% of the shares of the new entity, with Catalyst Health Solution's shareholders holding the remaining.

Shares in both companies performed really well today. As a result of the 11% increase in SXC Health Solution's stock the bid for Catalyst has implicitly risen to $86.55. After rallying 34% today, shares in Catalyst ended the day at $85.23, a 1.5% discount compared to the offer.

Investors are cheering

The market is extremely enthusiastic about the merger in which SXC is clearly the "acquiring" party. The 11% increase in shares of SXC to $88.63 represents an increase in valuation by some $550 million. Shares in Catalyst Health Solutions increase by some $1.2 billion, indicating that the combined entity market value increased by some $1.7 billion.


Both companies have reported strong revenue growth in recent years. Catalyst reported $5.3 billion in revenues for 2011, on which it earned a mere $67 million. SXC grew rapidly as well in recent years and reported $5.0 billion in annual revenues for 2011 on which it net earned $92 million.

The combined entity has $10.3 billion in revenues for 2011, on which it reported net income of $159 million. After today's $1.7 billion market value increase, the combined entity is valued at roughly $9.8 billion. This values the company at 1.0 times annual revenue and around 60 times earnings as the combination reports net profit margins of merely 1.5%

The merger of the two smaller, but ambitious pharmacy operators is an attempt to create a sizable competitor to compete with the likes of Express Scripts (ESRX) and Medco Health Solutions (MHS) which trade at 1.0 and 0.4 times annual revenues, respectively. Economies of scale play an important role in the pharmacy industry with both competitors reporting higher net margins of 2.8% and 2.1% respectively.

Investment Thesis

Investors are cheering in a reaction to the proposed merger agreement sending both stocks higher. The $1.7 billion increase in the combination's market value indicates that investors anticipate significant synergies in the near future. A successful integration of both companies could push net margins up towards 2.5% resulting in a company reporting roughly $10 billion in revenues and net income around $250 million.

This would still value to be combined company at roughly 1 times annual revenues and 40 times annual profits, a steep valuation for a medium-sized but fast growing pharmacy retailer.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.