Switching Gears In a Growth Strategy: McKesson Bets on the Meshing of Drug Distribution and Health Care Information

About three months after merger plans between HBO & Co. and McKesson Corp. collapsed when news of the deal leaked out prematurely, McKesson announced its intention to acquire HBO & Co. in a $14.5 billion deal. The merger would create a comprehensive health care supply management and information technology company, uniting the top-performing companies in their respective industries – McKesson in drug and health care supplies distribution and HBO & Co. in health care information products and services. After facing antitrust opposition in early 1998 to its planned acquisition of AmeriSource Health Corp., McKesson decided instead to pursue an acquisition of a company in a complementary industry that serves the same customer base. HBO is an expensive bet in that direction. However, the companies believe that their capacity to integrate and analyze information across the full spectrum of the health care industry would have major benefits for drug research, clinical development, product use, patient care, and the overall productivity of the health care system. Following the acquisition, the combined company, McKesson HBO, would be the world’s leading health care services company, with the greatest breadth of product offerings and deepest reach in both the health care supply and health care information markets. The two companies have a combined customer base of approximately 5,000 hospitals, 25,000 retail pharmacies, 35,000 physician practices, 10,000 extended-care sites, 600 payers, 450 pharmaceutical manufacturers, and 2,000 medical-surgical manufacturers. The corporate headquarters for McKesson HBO would be in San Francisco, where McKesson is based, and Atlanta, home of HBO, would be the headquarters for the health care information business. The combined company would have approximately 20,300 employees across the U.S., Canada, and Europe. McKesson, the largest health care supply management company in North America, provides health care products and services to retail pharmacies, hospitals, and health care networks. The company, which also owns McKesson Water Products Co., one of the nation’s largest distributors of bottled drinking water, has more than 13,000 employees. For the 12 months ended Sept. 30, 1998, it had revenues of $19.7 billion and net income of $207 million. With more than 7,300 employees worldwide, HBO develops patient care, clinical, financial, and strategic management software. It also provides a full range of network communications technologies and electronic commerce services. For the 12 months ended Sept. 30, 1998, HBO had revenues of $1.46 billion and net income of $284 million. Although the merger partners are quite optimistic that a combined company would be able to offer the most comprehensive array of products and technology to the health care industry, Wall Street was not impressed. In mid-July, HBO was ready to merge with McKesson but scrapped the deal as word leaked out and sent its share price downward. The market is treating the news of the current, proposed combination icily. The value of the deal dropped from $14.5 billion to $11.5 billion when HBO’s share price dropped soon after announcement of the transaction. High Margins and Favorable Trends Make HBO a Real Catch Both companies are information-intensive and both are leaders in their markets, but drug distribution has much lower margins and slower growth than the health care information technology business, which is facing some very powerful trends, such as the aging Baby Boomer population, the drive for cost-cutting in the health care industry, and the increasing use of information technology in business. The health industry is simultaneously striving to control costs and improve the quality of care, so providers and insurers are increasingly using computer networks and software to produce that result. These computer systems improve record and billing management, allow care providers to access more complete patient information, and provide decision-support software to provide the best patient care at the lowest cost. The Deal Partners Share a Focus On Industry Information Systems Despite the stock market’s pessimism, the merger partners, which have long used information technology as a tool to meet the needs of their customers, believe that their mutual focus on information, data, and automation avoids risks often associated with health care services, such as capital intensity, labor, and reimbursement. “According to the report of the U.S. Senate Labor and Human Resources Committee,” they said, “of the $1 trillion U.S. health care expenditures in 1996, $180 billion was spent on administrative costs and $330 billion on avoidable or inappropriate care. McKesson HBO, with its encompassing health care products and information flow, will use its combined resources, technologies, and customer knowledge to develop new offerings to address this opportunity.” HBO has itself grown exponentially through acquisitions. In the early 1990s, the company accelerated growth with a series of deals that expanded its product lines and extended its reach into new markets, such as physician offices, reference laboratories, payers, and home care. The company has spent more than $2 billion to acquire at least 20 companies in the last few years. Already established in the hospital and integrated delivery markets, recent acquisitions have bolstered HBO’s presence in the payer market and electronic commerce areas. The result is a full-service, “one-stop shop” for all the information technology needs of health care companies. Since September the company has added to the fold Access Health Inc., a health care-by-telephone innovator which runs an 800-number telephone line for emergency room nurse counseling and related services, in a $1 billion stock deal; HPR Inc., a provider of information systems for the managed care industry, in a $350 million stock deal; US Servis Inc., a professional management company providing outsourcing services for physician delivery systems and hospital business offices, for $47.4 million; and IMNET Systems Inc., an electronic information and document management product and service provider, for an undisclosed amount. McKesson also has been on a buying spree. Since September it has acquired J. Knipper & Co., a provider of direct marketing and fulfillment services to the health care industry, for an undisclosed price; Automated Prescription Systems Inc., a privately held manufacturer of prescription filling and dispensing systems, for $159.2 million; Red Lion HealthCare Corp., a subsidiary of Novartis AG which distributes medical supplies to the extended care industry, for $230 million in cash and assumed debt; and MedManagement LLC (a former division of Columbia/HCA Healthcare Corp.), a provider of pharmacy management, purchasing, consulting, and information services, for $42 million in cash. An elusive acquisition target for McKesson was AmeriSource. In September 1997, the company reached an agreement to buy AmeriSource in a stock deal valued at $1.79 billion. That proposed union came shortly after the industry’s second- and third-largest drug wholesalers – Cardinal Health Inc. and Bergen Brunswig Corp. – negotiated a $2.62 billion merger. In March 1998, the Federal Trade Commission went to court to block both mergers on antitrust grounds, arguing that the deals would give the two combined companies almost an 80% share of the $53 billion drug distribution market. The fates of the deals were sealed in mid-July when a federal judge in Washington ruled in favor of the FTC’s position. Antitrust Rulings May Spur Buyers To Acquire Numerous Small Targets Termination of those large drug wholesaler deals could spur efforts by some of the industry’s players to instead acquire numerous smaller players. Cardinal, Bergen, and AmeriSource have already announced intentions to continue to grow, via acquisitions. AmeriSource, the country’s fourth-largest drug distribution company, plans to target acquisitions of smaller drug wholesalers and look at buying companies in other businesses, such as pharmaceuticals packaging and surgical supplies companies. Bergen has expressed interest in pursuing acquisitions that will complement its pure-play distribution business. In August, Cardinal acquired R.P. Scherer Corp., which makes drug delivery systems for pharmaceutical companies, such as soft gelatin capsules and time-release tablets, in a $2.54 billion deal.