That will give them even more clout in demanding discounts from drugmakers, who are dealing with falling or stagnant revenue as blockbuster drugs taken daily by millions are getting cheaper generic competition.
Pharmacy benefit managers process mail-order prescriptions and handle bills for prescriptions filled at retail pharmacies. They act as middlemen between employers offering prescription drug benefits and drugmakers, extracting significant discounts, often in exchange for giving their brands preferred status over rivals' drugs. They also hold down costs with tiered copayments that nudge patients to buy generics or the lowest-cost brand names, and by reminding patients to take medicines as scheduled to limit costly complications.
Together, Express Scripts and Medco handled more than 1.7 billion prescriptions in 2010 and reported almost $110 billion in revenue. However, Medco, the bigger company by revenue, recently lost several major contracts covering millions of people.
Most of their revenue goes back out to pay for medicines, leaving the industry with razor-thin profit margins.
The combined company hopes to wring even lower prices from drugmakers, but it wasn't immediately clear whether that would benefit just their employer and health plan clients, or if some of those savings would be passed on to consumers in the form of lower copayments.
Patients might see tougher rules for getting medicines for chronic health problems by mail order or requiring more use of generics. Patients whose prescriptions are handled by either company shouldn't see any changes right away, as their drug benefit plans are covered under multiyear contracts.
The combination would double Express Script's market share to 30 percent, leapfrogging ahead of rival CVS Caremark, which has a 15 percent share, according to Atlantic Information Service, a health care information publisher.
The deal will reduce pharmacy choices for customers and could create negotiating headaches for pharmacies, said pharmacist Hamid Abbaspour, founder of the independent Dr. Aziz Pharmacy in Indianapolis.
"Every time you see these conglomerates combine ... it always brings up issues," he said.
Abbaspour, who does business with both Medco and Express Scripts, said their combination means independent drug stores might have more difficult negotiations because prescription benefit managers, or PBMs, have more leverage.
"We actually have to push to be part of their provider group," he said, because PBMs funnel business to their own mail-order pharmacies. "Sometimes they come to us and say, 'Take it or leave it,' and at some point it could put a huge financial burden on us if we say, 'We don't accept this unfair contract."'
PBMs do channel as much business as possible to mail order pharmacies, which reduce costs because they're mostly filling prescriptions for 90 days. That's often done in huge automated pharmacies, where robots and computerized conveyor-belt systems, rather than people, fill mail-order prescriptions.
The surprise deal was announced as Medco reported a 4 percent drop in second-quarter profit and said its contract with UnitedHealthcare covering 12 million people would end in December 2012.
The announcement follows a string of contract losses for Medco, the largest pharmacy benefits manager in terms of revenue. Last year, Medco had revenue of roughly $66 billion, compared with about $48 billion for CVS Caremark Corp. and $45 billion for Express Scripts.
On Thursday Medco said it has booked about $800 million in new business for 2012, which is far less than the business it has lost.
Express Scripts and Medco say they foresee only about $1 billion in savings from the combination, just under 1 percent of their revenue.
Express Scripts Chairman and CEO George Paz and Medco CEO Dave Snow declined to give details on those cost cuts during a conference call with analysts and said it's too early to discuss changes such as job cuts and facility closures.
Both executives stated repeatedly that their goals of driving out waste, reducing spending and improving patient outcomes align perfectly with those of the Obama administration and the health care overhaul.
"Everyone agrees that we need to get health care costs under control," Paz told the analysts. "It's what America needs, it's what the patients need, it's what the clients need."
Investors drove up the stock prices of all three top prescription benefit managers. In afternoon trading, Medco's stock price rose $8.23, or 14.7 percent, to $63.99. Express Scripts stock gained $3.13, or 6 percent, to $55.67. Shares in CVS Caremark, which operates the CVS drug store chain along with its prescription benefit business, climbed $1.05, or 2.8 percent, to $38.
In a ripple effect, drugstore chain Walgreen Co. was down 3.3 percent at $40.41 and drug wholesaler AmerisourceBergen Corp., whose biggest customer is Medco, fell 5.8 percent to $39.35.
Given that Medco handled the most U.S. prescriptions and Express Scripts was second last year, and they are ranked first and third, respectively, in revenue, analysts asked whether the Federal Trade Commission might oppose the deal or require some divestitures. Paz said he doesn't foresee problems because the combination benefits customers and the country.
"We wouldn't do this if we didn't think we could get it done," he said.
Under the deal, Express Scripts, of St. Louis, will buy Medco for $71.36 per share. Medco's shareholders will get $28.80 per share in cash and 0.81 shares of Express Scripts for each share they own. That's a premium of 27.9 percent based on Medco's closing price of $55.78 Wednesday. Shares of the Franklin Lakes, N.J., company have traded between $43.45 and $65.39 in the last year.
The deal is expected to close in the first half of 2012, pending approval from regulators and from shareholders of both companies. Paz will lead the new company, which will be based in St. Louis, and the board of directors will expand to include two independent Medco directors.
