In Lesson 2, we will discuss the Express Scripts and Medco Merger. Now, we will discuss a real-life merger between Express Scripts and Medco Companies on April 2, 2012. Some background information about the two companies was taken from their 2011 Annual Reports, before the merger. The two companies are pharmacy benefit management companies. The 2011 revenues of Express Scripts Company was $46 billion, and the total assets at the end of 2011 was $15.6 billion. Medco 2011 revenues was $70 billion and the total assets at the end of 2011 was $17 billion. All the information was taken from the real filings of the companies: The Annual Reports, the 10-Ks, and the S4 documents. The following was the structure before the merger on April 2, 2012. So, we have Expressed Scripts shareholders. They hold 100 percentages of Express Scripts Companies, and Express Scripts Company holds 100 percentage of New Express Scripts Company and New Express Scripts Company has two subsidiaries: Express Scripts Merger Sub and Medco Merger Sub. We also have the shareholders of Company Medco and they hold 100 percentages of Medco company. New Express Scripts was formed only to affect the business combination. It has two subsidiaries as we previously discussed. Express Scripts Merger Sub and Medco Merger Sub that also will form only to affect these specific mergers. These business combination involves two mergers. First, Express Scripts will merge with and into New Express Scripts and Express Scripts is the surviving company in the merger. Second, Medco will merge with and into Medco Merger Sub, and Medco is the surviving company in the merger. As a result of the mergers, both of the surviving companies– Express Scripts and Medco–are the subsidiaries of New Express Scripts. These are the two mergers. Express Scripts with Express Scripts sub and Express Scripts is the surviving company in the merger. Also, Medco with Medco Merger Sub, and Medco is the surviving company. What consideration was received by Express Scripts shareholders in this specific merger? Each share of common stock of Express Scripts was converted into one share of common stock of New Express Scripts. It means the exchange ratio was one-to-one. What consideration was received by Medco shareholders? Each share of common stock of Medco Company was converted into $28.8 in cash plus 0.81 shares of common stock of New Express Scripts Company. So, this is the structure after the merger. The question is: What companies account the acquirer and what companies account the acquiree in this specific merger? As we previously discussed, to determine the account the acquiree, we need to calculate the percentage of ownership, the former Express Scripts and former Medco shareholders have in the new company, the New Express Scripts company. From the 2011 Annual Report- the 10-K document of Express Scripts– we can see that before the merger on February 29th, 2012, Express Scripts Company had approximately 485 million shares of common stock outstanding. From the 2011 Annual Report, the 10-K documents of Medco company, you can see that before the merger on March 23, 2012, Medco had approximately 392 million shares of common stock outstanding. So, the question is: What company is the legal acquirer, the accounting acquirer, and the accounting acquiree in this specific transaction? Based on the 2011 Annual Report of Medco company, we know that on March 23, 2012, Medco had approximately 392 million shares of common stock outstanding. Since each share of Medco was exchanged for $28.8 in cash and 0.81 shares of New Express Scripts Company's shares, Medco shareholders received approximately 318 million shares of New Express Scripts Company. We can see that 392 million multiplying by 0.81, you'll get approximately 318 million shares of New Express Scripts Company. Based on the 2011 Annual Report of Express Scripts Company, we know that on February 29, 2012, Express Scripts had approximately 485 million shares of common stock outstanding. Since each share of Express Scripts was exchanged for one share of New Express Scripts, Express Scripts shareholders received approximately 485 million shares of New Express Scripts Company. So now, we can calculate the percentage of ownership in the New Express Scripts Company held by Express Script shareholders and Medco shareholders. Express Script shareholders have approximately 60 percentages of New Express Scripts Company, while Medco shareholders received approximately 40 percentages of the Express Scripts Company. Because the shareholders of Express Scripts received approximately 60 percentages of the voting interest in the New Express Scripts, Express Scripts is the accounting acquirer and Medco is the accounting acquiree in this merger. Please note, before the merger, Medco was the larger company. So, New Express Scripts is the Legal Acquirer. Express Scripts is the Accounting Acquirer and Medco is the Accounting Acquiree. Let's read about this merger from the 2012 Annual Report of Express Scripts. Upon closing of the merger, former Express Scripts shareholders own approximately 59 percentages of Express Scripts and former Medco shareholders own approximately 41 percentages. We calculated the percentage of ownership of approximately 60/40, only one percentage difference. The reason for this difference is that we do not know the exact number of shares outstanding on April 2, 2012, which was the business combination date. We used very close dates from the 2011 Annual Reports of Medco and Express Scripts Companies. From the 2012 Annual Report of Express Scripts, we can see that in this business combination, the consideration transfer included cash, shares of common stock, and stock options, and restricted stock units. The total fair value of all the consideration transferred was approximately $30 billion and $154 million. On the business combination date, April 2nd, 2012, the opening stock price of Express Script company was $56 per share. The question is, how can we calculate the cash and shares of common stock components of the total fair value of the consideration transferred to acquire the Medco company? As you remember, for each share of Medco company, Medco shareholders received $28.8 in cash and also 0.81 shares of New Express Scripts Company. On the business combination date, Medco is approximately 192 million shares of common stock outstanding. Thus, the total amount of cash paid was approximately $11 billion and $290 million. The fair value of shares issued can be calculated as following. Medco Company had 392 million shares of common stock, and each share of common stock of Medco was exchanged for 0.81 shares of New Express Scripts. The listed market price per share was $56.49. So, all in all, it was approximately $18 billion. As you can see, these numbers are very close to the real numbers reported by Express Scripts in its financial statements. As we previously discussed, the minor differences are due to the fact that we use Medco shares outstanding on March 23, 2012, while the real acquisition date was April 2, 2012. The fair value of the stock options issue to the holders of Medco stock options is $706.1 million. So, it is included in the total consideration transferred in a business combination. These stock options were issued for the pre-combination services rendered by Medco employees. As it is written in the financial statements of Express Scripts Company, in accordance with the applicable accounting guidance, the fair value of replacement evolves attributable to pre-combination service is recorded as part of the consideration transferred in the merger. While the fair value of the replacement awards attributable to post- combination service is recorded separately from the business combination, and recognized as compensation costs in a post-requisition period over the remaining service spirit. As you can see, the accounting for stock options issued on a business combination date is exactly the same as we discussed in the previous lesson.
