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.
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.
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
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|
A 15.98% annual return is appealing. I think there is less risk than currently priced into the merger.
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|
|Minus Expected Debt||41100||41100||41100|
|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|
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.
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.
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.
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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.
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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.