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Morningstar | Pending Tie Up Between Cigna and Express Puts the Combined Entity on Better Competitive Footing

The managed-care sector has been driven by turbulence over the past five years, and this dynamic is likely to be a major factor over the next several years. As a result, Cigna has made a major strategic move to acquire the largest independent pharmacy benefit manager, Express Scripts, in order to position itself for long-term success. Operationally, we believe this is great strategic move for Cigna, as it will acquire a wide-moat healthcare player with services that will grow ever more critical over the next several years. We also believe the managed-care firm is paying a fair price and, considering potential synergies, the deal is likely to create shareholder value.Independently, Cigna's health insurance business has the potential to develop a moat, given its large membership base. However, the capital and asset usage of Cigna's disability, life, reinsurance, and supplemental insurance lines is a significant drag on firmwide returns on invested capital. This leaves Cigna at a disadvantage in the face of seismic industry changes. We believe the MCO industry will now encompass a significantly greater degree of transparency, competition, and costs.With this as the backdrop, we believe the firm's decision to merge with Express Scripts is the correct move. From our perspective, the combined entity will benefit from superior client member management, centralized cost scale advantages, and a more diversified business model. The deal is expected to close toward the end of 2018, and we expect only moderate (if any) regulatory pushback. Historically, the federal government has looked favorably upon PBM deals, and it approved a similarly large acquisition when UnitedHealth purchased Catamaran in 2015.This fact, combined with the government's extensive PBM contracts for its own employee health insurance plans, gives us confidence that a Cigna/Express Scripts merger is likely to close by year-end. We believe the deal will offer both firms an opportunity to drive value-creating synergies and give them an enhanced service portfolio to compete with UnitedHealth and the combined CVS/Aetna organization.