SmithKline in pounds 1.6bn US deal: Anglo-American giant buys bulk drug supplier to further 'total health care' ambitions

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The Independent Online
SMITHKLINE Beecham is paying more than dollars 2.3bn (pounds 1.6bn) for Diversified Pharmaceutical Services, a US pharmaceutical benefit management company.

The Anglo-American giant aims to use the deal to catapult itself from a drug company into a 'total health care' group over the next three years.

The takeover follows a similar dollars 6.7bn move by Merck, the world's largest drug company, last November and is a response to the way in which cost pressures are transforming the US healthcare industry.

Diversified is one of the largest pharmaceutical benefit managers (PBMs) in the US, responsible for meeting the drug needs of around 11 million individuals through a network of 30,000 pharmacies.

As part of the deal SmithKline will also get exclusive access for six years to data about the 1.6 million members of healthcare schemes run by Diversified's parent, United HealthCare. SmithKline plans to use this information to assess the cost effectiveness of various drug and treatement regimes.

United, one of the biggest US healthcare management companies, has agreed not to launch a competing PBM for at least six years. It will also receive a management fee for all business it introduces to Diversified. The fee will be 0.5 per cent of all prescriptions processed or administered by Diversified in the first two years of the agreement, 0.6 per cent in the second two and 0.7 per cent in the final two.

PBMs such as Diversified have grown rapidly over the last few years in the US.

It is their job to supply drugs as cheaply as possible to members of healthcare management plans. Such plans have been the market's response to the spiralling cost of health care in the US, which is often met by employers.

As they buy in bulk, PBMs have been aggressive negotiators of discounts with big drug companies. They are in a strong position to do so, since as well as purchasing the drugs they are responsible for drawing up 'formularies' or lists of approved drugs for which the patient will be reimbursed.

PBMs make their profits through charging their clients a transaction fee for processing claims and also by keeping a percentage of the discounts they achieve.

Around 50 million Americans, more than a fifth of the population, are now covered by PBMs, of which Diversified is one of the largest. Drugs to the value of dollars 2bn were dispensed under its aegis in 1993.

Around 10 per cent of Diversified's business, worth about dollars 80m in 1993, is in capitated drugs - where a PBM agrees with an employer to supply all its employees' drug needs for a fixed cost per person per year.

Jan Leschly, SmithKline's new chief executive, said that the company planned to evolve from simply selling pills to becoming a manager of total health care over the next three years.

It had spent more than a year analysing how to respond to the changes in US health care and had concluded that a link-up with a PBM and a health management organisation was essential.

'We all know that the environment in which we work is changing rapidly,' he said. 'The winners will position themselves to capitalise upon those changes. Those who fail to adapt will lose.' He said the close analysis of the cost and benefits of different sorts of treatment that was becoming a feature of the American system would eventually spread to Europe as well.

A drug company's sales would increasingly be determined by its ability to demonstrate such a relationship. That was why SmithKline attached so much importance to its ability to draw on United's treatment data, he said.

The purchase, which will be paid for with a mixture of cash and commercial paper, will modestly dilute earnings this year, although SmithKline insisted that the effect would not be significant. Diversified earned only dollars 40m last year on revenues of dollars 142m, but Mr Leschly said SmithKline based its valuation on the number of individuals covered by the company. On that basis Merck had paid dollars 325-dollars 360 per life for each of Medco's 15-19 million lives, while SmithKline paid only dollars 210 for each of Diversified's.

The purchase of Diversified is conditional on the deal gaining anti-trust clearance. As with the merger of Merck and Medco last November, the combination of drug manufacturing and purchasing raises legal concerns about vertical integration. A number of drug chains and rival pharmaceuticals groups have challenged the Merck-Medco merger on anti-trust grounds. That suit is still pending.

The market judged the move a good one. SmithKline's 'A' shares rose 25.5p to 415p. The sector was also helped by weekend news of the Swiss group Roche's dollars 5.3bn takeover offer for the US group Syntex.

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