CHSI Catalyst Health Solutions, (MM)

Pharmacy-benefit manager SXC Health Solutions Corp. (SXCI, SXC.T) agreed to buy rival Catalyst Health Solutions Inc. (CHSI) in a roughly $4.14 billion cash-and-stock deal to boost the companies' position in a consolidating sector.

The latest deal -- long-speculated on Wall Street -- combines two mid-sized players in an industry that handles drug benefits for health plans and corporate customers. A merged SXC and Catalyst would be the industry's fourth-largest by retail pharmacy claims, and could be in a better position to compete and win contracts from big clients.

The two pharmacy-benefit managers already have had success capturing business, a trend that the Federal Trade Commission highlighted in approving a much bigger PBM merger earlier this month. In general, size in the PBM market matters, said Mark Thierer, SXC's chairman and chief executive.

"To win in the space, you've got to have skill and scale," he said in an interview. The combined company can "compete at a whole new level," he said.

The smaller PBMs have traditionally been more flexible in letting customers pick and choose the kind of services they want, such as use of mail-order pharmacies, said Edward Kaplan, national health practice leader at The Segal Company, where he does consulting for PBM clients. According to Kaplan and Thierer, big clients are increasingly looking for this kind of flexibility.

Meanwhile, Thierer said he also expects the sector -- which is filled with dozens of smaller, regional firms -- will see yet more consolidation.

Shares of both companies surged on Wednesday's news, with SXC rising 11% to close at $89.36 and Catalyst climbing 34% to $85.23, near the per-share price of the cash-and-stock deal.

Wednesday's deal announcement comes just two weeks after Express Scripts Holding Co. (ESRX) secured antitrust approval and completed its $29.1 billion acquisition of Medco Health Solutions Inc. to create the industry's biggest firm. Behind Express Scripts is CVS Caremark Corp. (CVS) and a PBM run by UnitedHealth Group Inc. (UNH).

Pharmaceutical industry consultant Adam J. Fein estimated a combined SXC and Catalyst, with combined sales of $13 billion, will handle about 8% of store-based retail prescription claims this year.

"They're creating a credible company in the PBM space that can start to go head-to-head with the larger companies," said Fein, who is president of Pembroke Consulting Inc.

Thierer will remain head of the combined company, while Catalyst CEO David T. Blair is expected to stay on for a transition period. The companies expect the deal to close in the second half of this year, pending shareholder and regulatory approval.

Despite big questions about whether Express Scripts could win approval to buy Medco, those firms wound up gaining FTC clearance without any conditions, suggesting room for smaller-scale deals. The FTC cited both SXC and Catalyst when describing industry competitiveness, noting those two firms "are experiencing considerable growth."

One question is whether integrating the companies might foment disruption that causes customer loses or makes winning business harder. Both companies were expected to benefit this year from the industry shake-up set off by Express Scripts' Medco purchase. William Blair analyst Amanda Murphy was surprised that SXC and Catalyst announced their deal during the period when PBMs try to solicit new business, known as the selling season, which lasts until late summer or early fall.

Thierer acknowledged some potential for disruption, but also said integration challenges will be muted because Catalyst already runs on the software that SXC sells as part of its healthcare information-technology business. Both SXC and Catalyst also have indicated that they're competing busily for new business.

"I'm bullish about our prospects in the selling season," Thierer said.

The deal offers Catalyst shareholders a mix of cash and SXC shares that valued Catalyst at a 28% premium to the company's closing price on Tuesday. Under the deal, Catalyst shareholders will swap each of their shares for $28 in cash and 0.6606 SXC shares.

The companies pegged the value of the deal at roughly $4.44 billion, a figure that includes the assumption of debt. The deal is pricier than previous PBM deals but reasonable given the higher growth rate of Catalyst Health, Leerink Swann analyst David Larsen said.

SXC expects the transaction to give a boost to its earnings next year, excluding transaction-related amortization expense of about $200 million in the first 12 months after closing.

In the meantime, the companies anticipate roughly $125 million of annual cost savings over the first 18 months to two years after closing the deal. They also expect $40 million to $45 million in transition expenses to get those savings.

If the transaction is successful, SXC shareholders would own about 65% of the combined company, and Catalyst shareholders are expected to own the remaining 35%. The combined company will be headquartered in Lisle, Ill., where SXC is based.

-By Jon Kamp, Dow Jones Newswires; 617-654-6728; jon.kamp@dowjones.com

(Mia Lamar contributed to this article.)

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