Fitch Places Medco Health's IDR on Rating Watch Negative

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CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has placed Medco Health Solutions (NYSE: MHS) Issuer Default Rating (IDR) on Rating Watch Negative following the company's announcement that it has entered into an agreement to be acquired by Express Scripts'(NYSE: ESRX) for approximately $29.1 billion (40% cash/60% stock). The transaction is expected to close in the first half of 2012. In addition, the ratings associated with ESRX were also placed on Rating Watch Negative with this announcement.

RATING RATIONALE:

The Negative Watch recognizes the likely increase in leverage required to complete the transaction. Fitch estimates that leverage (total debt/EBITDA) of 2.7 times (x)-2.9x (including the assumption of MHS' debt) will be required to satisfy the cash component of the deal. However, Fitch believes the combined firm could significantly reduce leverage in the 18 months following the close of the transaction.

Fitch expects to resolve the Rating Watch once it has a better sense of the combined company's capital structure and the requisite regulatory approvals have been obtained or denied. A one-notch downgrade is likely if the acquisition is completed. If the acquisition does not go through, Fitch would also weigh the impact that recent contract losses may have on MHS's credit profile.

KEY RATING DRIVERS:

The key rating drivers for this credit are leverage measured as total debt-to-EBITDA, EBITDA margins, and free cash flow. The 'BBB' leverage range for this credit is approximately 1.5x-2.0x. Margin variability of less than 90 basis points and material free cash flow generation are expected for this rating.

STRATEGICALLY SOUND:

Fitch believes the business combination is strategically sound, as it creates significant synergies, bringing together a focus on behavioral economics and optimal drug therapy protocols. ESRX's stated $1 billion of synergies are achievable, given the similar nature of both companies' operations and the company's success with integrating past acquisitions. Nevertheless, the proposed acquisition is ESRX's largest ever, and as such, it presents integration risk.

ANTITRUST CONCERNS:

Combining two of the three largest Pharmacy Benefit Managers (PBMs) may raise antitrust issues. Fitch believes that if the Federal Trade Commission considers the broader U.S. prescription dispensing market (including standalone PBMs, captive PBMs, and drug stores) and the PBM business model alignment with moderating drug costs for payers and patients, the proposed merger can pass regulatory muster, although regulatory risk is present.

CLIENT LOSSES/OPERATIONS:

MHS has recently incurred a few key contract losses. Taken together, the losses account for more than 15% of MHS's revenues, although they are less profitable than the company's average book of business. It appears that the causes of the losses varied, and not all were entirely controllable by MHS. Should MHS remain an independent firm, Fitch expects that the company would adjust its cost structure to reflect the net effect of client wins and losses. While Fitch believes MHS remains competitively positioned by expanding and differentiating its service offerings for clients and maintaining its traditional methods to improve the efficiency of drug therapy, the recent contract losses are a cause for concern.

ADEQUATE LIQUIDITY:

MHS has adequate liquidity and access to the credit markets. At March 26, 2011, the company had liquidity of approximately $170 million in cash and short-term investments and $1 billion availability on its revolving credit facility. The company also has $600 million availability on its receivables facility. MHS generated approximately $1.9 billion of free cash flow for the latest 12 months (LTM) ended March 26, 2011.

At March 26, 2011, MHS had roughly $5 billion in debt, with approximately $1 billion of a term loan maturing in 2012, $800 million in notes maturing in 2013, $500 million of notes maturing in 2015, $1.2 billion in notes maturing in 2018, and $500 million in notes maturing in 2020. MHS also had $1 billion outstanding on its $2 billion revolving credit facility, which matures April 30, 2012. Leverage was 1.59x.

Fitch has placed the following ratings for MHS on Rating Watch Negative:

--IDR 'BBB';

--Senior unsecured bank credit facility 'BBB';

--Senior unsecured notes 'BBB'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 16, 2010).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Amended

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646

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