With AT&T (T) and Time Warner (TWX) currently fighting in court to prevail over the federal government in its anti-trust lawsuit, all eyes in the merger arbitrage world are focused on whether so-called “vertical” mergers will be endangered in the Trump Administration. Typically, lawsuits to block M&A transactions have centered on competitors trying to get together to reduce competition and increase pricing power post-combination, but the current fight puts vertical integration in the crosshairs, as the infrastructure company is trying to add content to diversify its business. Given how low sentiment is on Wall Street for paid television content production, investors clearly don’t believe a simple merger would give the content producers monopolistic power, but we will have to see what judges think.
One of the more interesting cases is Express Scripts (ESRX), the large pharmacy benefits management company that was recently (March 8th) offered a 31% premium to be acquired by health insurer Cigna (CI). Many believed that ESRX was in play after becoming the lone major PBM to not have a dance partner. And after CVS Health (CVS) — which owns another large PBM in Caremark — made a bid for Aetna (AET), it was clear that insurance and pharmacy benefits management were consolidating to the point where ESRX as a standalone business was becoming obsolete.
Express Scripts stock was trading at $73 when the $96 deal price was announced, and the stock jumped initially… for a few hours. It now fetches around $70, as investors bet that vertical mergers, even if allowed in the media business, have a steeper hill to climb, in part because multiple deals are pending and allowing all of them to go unchallenged, could be seen as risky by the government.
With ESRX having 28% upside if the deal is allowed, it might seem like a no-brainer risk/reward situation to go long the stock. After all, at current prices the shares trade for just 10x 2017 earnings per share, with that multiple falling to just 7.5x if you believe the mid-point of the company’s 2018 earnings guidance ($9.37), which is getting a big boost from a new, lower corporate tax rate.
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