New Company Valuation, Express Scripts Reaps, Cigna Weeps

Mar. 13, 2018 10:12 AM ETExpress Scripts, Inc. (ESRX)ELV, CI17 Comments
Reid Schaworski profile picture
Reid Schaworski
237 Followers

Summary

  • The recent offer from Cigna provides an excellent opportunity to buy Express Scripts with limited downside.
  • Express Script's CEO is very long Express while Cigna's CEO is short Cigna.
  • Express is trading at a significant discount from the offering price and I believe the new company's value is greater than what the market is currently pricing it.
  • I see greater upside than downside even when considering rejection of the merger from regulators.
  • Shares of the new company will trade around or above $200 maybe up to $300 based on a deconstructed EV/EBIT and P/E Valuation.

Cigna Corporation (NYSE:CI) has announced the purchase of Express Scripts Holding Company (NYSE:NASDAQ:ESRX) yesterday. The deal is valued at $67 billion, Cigna is offering $48.75 in cash and 0.2434 shares of stock in the combined company per Express Scripts share. Cigna will also take on Express Scripts $15 billion in debt. The transaction has been approved by both companies' board of directors. The deal which is expected to close December 31st, 2018.

Insider Moves

The purchase price represents a 31% premium over Express Scripts March 7th closing price. Cigna shareholders will own 64% of the new company and Express Scripts shareholders will own 36% of the new company. David Crodani will be the President and CEO of the new company. Interestingly David Crodani sold 67,070 shares on March 5th for total proceeds of nearly $13 million. The stock sold was received as proceeds from 2015-2017 strategic performance. David's reduced his security holdings of Cigna by 18% only days before the announced merger. In the first week of March thirty three form 4 Statement of Changes in Beneficial Ownership were filed with the SEC for Cigna. Many were purchases of small amounts of stock, but the CEO's disposition is the most significant of all.

Tim Wentworth the CEO of Express Scripts be the President of Express after the merger. Tim acquired 108 499 shares in Express on March 6th from long-term incentive plans for aggregate proceeds of approximately $8.1 million. Tim only sold 12 808 shares for proceeds of a little less than $1 million. His decision to keep 88% of his new $8 million of stock in contrast to David Crodani's liquidation makes me bullish on Express Scripts.

The Purchase Price

Unsurprisingly we saw Express's share price jump up 15% on open but closed only 8.58% higher after the announcement. Cigna Corp. opened 7% down and closed 13.5% down. Express Script's market cap has is currently $45 billion, a 13.46% discount to the net of debt offering of $52 billion by Cigna. I attribute this discount three factors

  1. The time until closing. Using T-Bills the Risk-Free Rate about 2% for the time period.
  2. Risk the deal will not be approved by regulators. In 2015 Cigna attempted to buy Anthem (NYSE:ANTM) which was rejected by regulators. The majority of the remaining 11.5% discount from the offer reflects market sentiment that the deal will not get regulatory approval.

The Upside

Express Scripts is worth the risk buying below $82 per share. The offer is attractive and provides a significant upside over the current share price assuming approval is given.

Cash per ESRX Share $ 48.75
CI Share Price $ 174.00
CI/New Company Shares per ESRX Share 0.2434
Value of Cigna/New Company Shares $ 42.35
Implicit value of ESRX Today $ 91.10
ESRX Current Share Price $ 80.75
Implied Upside $ 10.35
Return 12.82%
Annual Return 15.98%

A 15.98% annual return is appealing. I think there is less risk than currently priced into the merger.

New Company Valuation

The new company could provide excellent value to Express Script holders. Cigna will issue 137 million shares to Express Scripts shareholder bringing the share base of the new company to 380 million common shares. A deconstructed Enterprise Value/2017 EBIT valuation show what the new company could be worth. The EV/EBIT valuation is great for taking a snapshot of the company and valuing it at a certain time; I feel a discounted cash flow has too many variables and the terminal value makes the model too error prone.

New Company Share Price Deconstructed EV/EBIT Valuation
CI EBIT 2017 3606
ESRX EBIT 2017 4929
Combined EBIT 2017 8535
Admin Synergy Savings 600
EBIT 2018 (All else equal) 9135
EV/EBIT Multiple 11 12 13
Enterprise Valuation 100485 109620 118755
Minus Expected Debt 41100 41100 41100
Add Cash 7200 7200 7200
Market Cap Valuation 71985 81120 90255
Expected Share Base (Millions) 380 380 380
Projected Share Price $ 175.22 $ 199.26 $ 223.20

Data about expected debt, cash and synergies can be found here and here. No one can predict the future. Assuming 2018 EBIT is the same a 2017 is conservative considering the combined growth of these companies' earnings in recent years. Management does estimate synergies of $600 million or greater but there is no way of knowing if synergies will be realized next year. The EV/EBIT multiples used are based industry averages from two separate sources.

Now consider the value of Express Scripts today considering the new companies valuation and the cash offering.

Cash per ESRX Share $ 48.75
Deconstructed EV/EBIT Share Price $ 199.26
New Company shares per ESRX Share 0.2434
Value of Newly Issued Shares $ 48.50
Implicit Value of ESRX $ 97.25
ESRX Current Share Price 80.75
Implied Upside $ 16.50
Return 20.43%
Annual Return 25.67%

The value of the new company shares will mostly be dependent on the share price of Cigna and whether or not the buyout is approved. The new company will also benefit from a reduced tax rate thanks to new legislation which will help their earnings per share. Management has a target of $20-$21/per share of earnings for 2021 with a base of $18 and accretion adding $2-3. I don't expect the new company to have a P/E of greater than 15 considering Express's low P/E and Cigna's P/E in the high teens. Even a P/E of 14 the share price is implied to trade around $252 and up to $294 in 3 years.

I can certainly see shares of the new company trading above $200.

The Downside

Worse comes to worse and the deal falls through I will still retain my Express Scripts shares which I will be more than happy to. I could see the share price of Express falling into the 60's if the deal is a no go. It might hurt to see paper gains disappear for a time but, considering I first bought Express in the mid 60's months ago and since that time I don't think the company has materially changed besides the takeover offer. I think the company is certainly undervalued in 60 to low 70's price range and would happily add to my position. To me there isn't much of a downside and the buyout is bringing Express Scripts closer to fair value.

Conclusion

The buyout provides an excellent catalyst for Express Scripts, I think around $80 per share is a fair price for the company even if Cigna was not interested in acquiring them. Express is an excellent company with a history of stable growth. I could see Express trading sideways until the regulators make a decision. There certainly is an excellent upside opportunity for the next year or two. If approval is given I expect to see both Express Scripts and Cigna shares trade higher. The new company offering looks attractive if the price is right. The new company will likely trade around or above $200 per share initially with the potential for significant price appreciation.

This article was written by

Reid Schaworski profile picture
237 Followers
My investing career started at age 18 and since then over the 8 year period my compound annual growth rate is 13.24% after costs. I focus on finding deep value and long picks. I never hold more than 15 positions at a time. I am Canadian investor with an eye on North American markets and occasionally international companies. Follow me and you will be exposed to some of the cheapest stocks in the market. Always looking for the next opportunity, whatever it may be.

Disclosure: I am/we are long ESRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Follow me for new long/short investing ideas.

ESRX is about 5% of my investment portfolio. I will buy more ESRX if the proposed buyout does not get regulatory approval and the share price takes a hit. For now I am long and plan on holding post-buyout. I will likely hold shares of the new company; valuation dependent.

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