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MEDCO CONTAINMENT ENTERING PHARMACY MANAGEMENT BUSINESS WITH DIAGNOSTEK ACQUISITION FOR $436 MIL.; DEAL COMBINES NUMBERS ONE AND FOUR MAIL-ORDER FIRMS

Executive Summary

Medco Containment is entering the pharmacy management business via the $436 mil. stock-swap acquisition of Diagnostek, a provider of pharmacy management services and mail-order pharmacy. Diagnostek provides staffing, purchasing and stocking, as well as management services for in-patient and out-patient pharmacies located in hospitals and staff model health maintenance organizations (HMOs where all staff are under one roof). The Albuquerque, N.M.-based company has 100 hospital pharmacy management clients as well as 31 HMO clients servicing 405,000 members. Members of Diagnostek's HMO clients are also offered the company's mail-order prescription service. A definitive merger agreement between Medco and Diagnostek was announced on Aug. 31. The acquisition is expected to be completed by the first quarter of 1993, contingent on approval by Diagnostek shareholders and federal regulatory authorities. The management of staff HMO and hospital formularies offers Medco a new avenue for its "preferred" drugs program. "Preferred" refers to a prudent purchase program of drugs obtained under discount contracts with manufacturers and selected by Medco for promotion and encouraged substitution. Medco told analysts in May that it expects 20% of sales to come from preferred drug programs by the end of 1992 ("The Pink Sheet" May 11, p. 7). The entree into hospital pharmacy formularies also provides Medco and its preferred provider clients the chance to influence prescribing patterns in the transition from hospital to outpatient use. In addition to providing entry into the pharmacy management services business, the acquisition of Diagnostek gives Medco access to the clients of what it called the fourth largest mail- order pharmacy provider in the U.S. Diagnostek, whose primary business is mail-order pharmacy, filled 2.85 mil. mail-order prescriptions during the year ended March 31. Based on a weekly figures provided in financial data from the year ended June 30, Medco dispenses approximately 27.3 mil. prescriptions a year by mail order, in addition to the 48.1 mil. prescription drug claims it processes annually through its network of 57,000 retail pharmacies. Medco said it will bring its "full complement of managed care pharmacy services and cost containment products" to Diagnostek's clients, resulting in "substantial cost savings to the employee benefit plan sponsors and incremental earnings to Medco." These services include offering Medco's preferred provider networks, claims processing and retail drug programs to Diagnostek's mail- order clients. Medco will also gain the added capacity of Diagnostek's two mail-order dispensing facilities, including a fully automated facility in Albuquerque. Under the terms of the agreement, Medco will issue approximately 14.6 mil. shares of common stock for all the outstanding Diagnostek shares, based on an exchange ratio of .625 Medco shares for each Diagnostek share. If the exchange ratio needs to be increased to ensure that Diagnostek shareholders receive Medco stock with a value equal to at least $15 per share, Medco has the option to change the ratio or cancel the merger agreement. Diagnostek also has granted Medco the option to purchase newly-issued shares representing 15% of the company's currently outstanding shares at $18.67 per share. The merger with Diagnostek is the second acquisition in the last month for Medco; on Aug. 17, the company announced its intention to acquire American Biodyne, a South San Francisco-based managed mental health care company, for 4 mil. shares of Medco stock, or about $121 mil ("The Pink Sheet" Aug. 24, p. 15). In April, Medco acquired Personal Performance Consultants, another mental health care company. However, negotiations with United Healthcare over a possible acquisition or merger were "terminated" in August ("The Pink Sheet" July 13, T&G-1, and Aug. 17, In Brief). Diagnostek reported revenues of $293.8 mil. for the year ended March 31 and $80.7 mil. for the three months ended June 30. Net earnings were $13.1 mil. and $3.6 mil., for the year and quarter, respectively. Bear Stearns is Diagnostek's financial advisor; Medco did not have an outside consultant to the deal.
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