Merck\'s Medco the Acquisition of Medco (by

Merck's Medco

The acquisition of Medco (by Merck) is a sign of shifts that are taking place in the health care industry. What is happening is there has been an emphasis on providing total health care solutions to consumers. As they are demanding that they have access to: the best services and want to have their different needs combined into one plan. This has lead to changes in the way health care services are delivered. As a variety of managed care plans have emerged to address these issues. Simply put, this is a health organization that will have their members pay them fees for the various services they require. As, this organization will negotiate with health care providers and drug manufactures; to offer their members the most cost effective solutions for addressing these different issues. Part of the reason for this, is because health care costs have been increasing dramatically and employers / individuals have been seeking out other solutions for addressing the problem.

In the case of Merck, they realized that they are facing tremendous challenges, by only being focused exclusively on the pharmaceutical industry. This pushed the company to purchase Medco, as a way to diversify their business model and respond to the changes that are taking place inside the sector. However, there have been differing opinions on the merger, with some executives believing that this will increase the overall bottom line. While there are other executives, who feel that the profit margins are so small that this is not a financially prudent decision moving forward. To see the true impact that this acquisition is having on Merck requires: examining these different views and determining the effect that it will have on the bottom line. Together, these different elements will provide the greatest insights, as to if the purchase of Medco is considered to be a wise decision for the organization. ("Merck and Company") ("Merck Medco Managed Care")

The different Views of Executives

Executives are divided on if: the acquisition of the Medco will increase the overall bottom line. As many of the Wall Street analysts believe that this action will help to increase the underlying amounts of long-term profitability. A good example of this can be seen with Goldman Sachs claiming, that this will increase the company's competitive leadership and allow them to become an active player in managed care services. Part of the reason for this, is because Medco is considered to: have a large customer base and the ability to cross market different services to them. As a result, a number of different drug manufacturers were talking with the Medco about: conducting some kind of strategic partnership or acquisition. According to proponents, the purchase of the company will have a number of different benefits. As, this will help Merck to become a major player inside: the pharmaceutical and managed care industries. A good example of this can be seen by looking at the size of the combined entity after the merger was complete. In this case, the acquisition would help to Merck to become one of the largest health care providers. The below charts illustrate the dominance that the new company inside the sector. ("Merck and Company") ("Merck Medco Managed Care")

("Merck Medco Managed Care")

("Merck Medco Managed Care")

The two charts are showing how without the acquisition, Merck was just another drug company. However, once it was complete, is when they would become a major player in: managed care services and pharmaceuticals. Evidence of this can be seen by comparing the revenues of the company between 1997 and 2001. As, this would increase from: $9 billion in 1997 to $26 billion in 2001. The below table illustrates the overall amounts of earnings growth that took place during this time. (Herper) ("Merck Medco Managed Care")

Revenues for the Combined Company between 1997 and 2001

Year

Revenues

1997

$9 billion

1999

$15 billion

2001

$26 billion

(Herper) ("Merck Medco Managed Care")

This is significant, because it shows how the merger between the two different companies caused the overall amount of revenues to increase dramatically. As Merck Medco, quickly became one of the most dominate players inside the industry by: offering a host of different services and products to consumers. In this aspect, various executives argued that the merger was necessary, to allow the company to adapt to changes that are taking place inside the industry. As it would provide Merck with a dramatic improvement in the overall bottom line results, while ensuring that they have the ability to deliver increasing amounts of revenue growth. (Herper) ("Merck Medco Managed Care")

The Impact that the Acquisition on Merck's Bottom Line

On the surface, it appeared as if Merck was redefining their business model, by expanding into areas that are quickly becoming in demand (managed care services). Yet, beneath the surface, it is clear that the profit margins were limiting the overall amounts of growth. What has been happening is the two companies did not strategically work well together. The reason why, is because Merck was known for developing breakthrough drugs (prior to the merger). Once they acquired Medco, is when everything would change. As the company began to lose focus on developing innovative pharmaceuticals that were in demand. Instead, they were concentrating on managed care services. The sharp increase in drug prices of 15%, from: the late 1990's into the early 2000's, meant that the profit margins they were enjoying were being whittled away by rising costs. This is problematic, because it is highlighting how Merck was benefiting from continuous amounts of innovation in the pharmaceutical business. Yet, the managed care division was a major drag on earnings for the entire company. A good example of this can be seen by comparing the PE ratios of the company, prior to the spinoff of Medco in 2003. The below table illustrates the differences in the PE ratios once this took place.

PE Ratios Before and After the Medco Spinoff

Time Frame

PE Ratio

Before Medco Spinoff

14

After Medco Spinoff

8

(Dickie 34 -- 35)

This is important, because it shows how the Medco spinoff, would help to reduce the overall costs that Merck was experiencing. Inside the PE ratios, this was reflected in the form of higher valuations, which would have a direct impact on earnings and the return that shareholders were receiving.