Acquisition Leaves Medco's Future In Question

The five-year credit-default swap spread of Medco Health Solutions widened last week after it looked like the prescription drug benefit manager would lose business from client UnitedHealth Group which is set to acquire PacifiCare Health Systems. PacifiCare has its own in-house drug benefit management unit.

"When UnitedHealth announced it was buying PacifiCare, Medco's equity sold off and its CDS spread widened about 10 basis points," said one trader, explaining the acquisition led market players to believe UnitedHealth would begin buying drugs through PacifiCare rather than Medco. The trader noted Medco generates 18% of its revenue from doing business with UnitedHealth, a major medical insurance company, adding the two have a contract until 2008 when UnitedHealth has the option to exit.

The trader said last Thursday, Medco's bid/offer spread stood at 60/70bps, slightly wider than the 55/65bps spread level the week before. He noted the New Jersey-based company's spread had pulled in slightly by the week's end, after UnitedHealth issued a statement claiming it has no intentions of altering its relationship with Medco.

Standard and Poor's gives Medco a BBB credit rating. Arthur Wong, an analyst with S&P in New York, said Medco's outlook would remain stable. If UnitedHealth does build out Pacificare's in-house unit, it would still take years before the business was able to cater to UnitedHealth's large customer base, he added.