McKesson - McKesson Makes a Deal Phyllis G Holland John E...

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Unformatted text preview: McKesson Makes a Deal Phyllis G. Holland, John E. Oliver, Peter M. Bergevin, and Kenneth L. Stanley E dward Lyle, a member of the Board of Directors of McKesson Corporation, was intrigued by the merger proposal that had just been described to him by Mark Pulido, McKesson’s Chief Executive Officer (CEO). Lyle had been a McKesson director for a number of years and had seen McKesson acquire several other companies, with varying degrees of success. He knew that anticipated synergies were not always realized‘and was concerned about a tendency to'pay premium prices when making acquisitions. He was also aware of a trend toward naming direc- tors in stockholder suits about failed acquisitions. Most importantly, he knew that his responsi- bilities as a Director required that he give this proposal careful scrutiny (see Exhibit 1). McKesson Corporation McKesson Corporation was founded in 4-1833 and was a leading provider of health care prod- ucts and services to independent and chain pharmacies, hospitals, and other health care orga nizations throughout the United States and Canada. Once the largest liquor distributor in the United States, McKesson had been through many cycles of acquisition and divestiture as it had sought to dominate various markets. Headquartered in San Francisco, the company distrib— uted health and beauty products, bottled drinking water, Specialty foods, and general mer- chandise. Current management believed that the health care industry offered the best oppor— tunities for McKesson. The company was listed on the New York and Pacific Stock Exchanges. McKesson was the major wholesale distributor in the pharmaceutical industry, an indusu try where net profits averaged around 2% and mergers were common. To compete, a company must be innovative and cost conscious; McKesson had managed this by offering high-margin generic drugs and investing in technologies that lowered both McKesson’s and its customers’ costs of distributions: Investments in information technology, including Web-based systems, enhanced McKesson’s speed and accuracy in filling orders and managing its inventories. McKesson shared its technological advantages with its customers, and that made McKesson the supplier of choice for many pharmacies. McKesson systems supported every aspect of pharmacy operations (see Exhibit 2). The company was positioned to do well in the managed care environment, in which generic drugs are substituted for patent drugs and in which excel— lent information systems enable pharmacies to maximize profits. This case was prepared by Professors Phyllis (3. Holland, John E. Oliver, Peter M. Bergevin, and Kenneth L. Stanley of Valdosta State University. Copyright © 2002 by Phyllis G. Holland, John E. Oliver, Peter M. Bergevin. and Kenneth L. Stanley. This case was edited for SMBP-ch Edition. Reprinted by permission. 4-1 SECTION A CORPORATE GOVERNANCE, SOCIAL RESPONSIBILITY, AND ETHICS Exhibit 1 Board of Directors’ Liability The Delaware General Corporation Law (DGCL) permits a corporation to include a provision -in.,its..certifieate. of incorporation limitingthe personal liability of a director Or an officer to the corporation or its stockholders for damages for a breach of the director's fiduciary duty, subject to certain limitations. The McKesson Certificate includes such a provision, to the maximum extent permitted by law. The DGCL also permits a corporation to indemnify officers, directors, employees, and agents for actions taken in good faith and in a manner they reasonably believed to be in, or not opposed to, the best interests of the corporation and with respect to any criminal action, which they had no reasonable cause to believe Was unlawful. The DGCL further provides that a corporation may advance expenses of defense (upon receipt of a written undertaking to reimburse the corporation it indemnification is not appropriate) and most reimburses successful defendant for expenses, including attorneys’ fees, actualty and reasonably incurred, and permits a corporation to purchase and maintain liability insurance-for its directors. and officers. The DGCL provides that no indemnification may be made for- any claim, issue, or matter as to which a person has been adjudged by a court of competent jurisdiction, after exhaustion of all appeals therefrom to be liable to the corporation, unless and only to the extent a court determines that a person is entitled to indemnity for such ' expenses as the court deems proper. McKesson indemnifies its agents to the extent that they are found to be acting in good faith. - - Source: Proxy Statement/Prospectus, McKesson Corporation, November 27, 1998. Since the early 19905, McKesson had acquired several companies in an effort to pursue v? its mission of becoming the world leader in health care supply management by assisting its customers in improving patient care while lowering or controlling costs. McKesson acquired General Medical, Inc. (the largest US. distributor of medical-surgical supplies), FoxMeyer Corporation (a bankrupt drug distributor), and Automated Healthcare, Inc, to improve supply management, information technologies, automated logistics, managed care,’ electronic connectivity, and customer service programs. Although the acquisitions were not Exhibit 2 McKesson Programs and Systems for Pharmacy Operation Front office (in-store) activities: Physically dispensing products (FIXOBOT), promotions - (Healthy Value$), point-of-sale applications (McKesson POS) catalogs of products (Home Health Catalogs)- Advice and support for business activities. Support for filling preScriptlons (Pharmaserv), tracking dispensing records (Pharmaserv), providing advice on drug interaction (Omnilink), managing generics (McKesson Select Batteries), monitoring benefits and heatth plan coverage (Omnilink Caremax, Integrated Medical Systems) Back office administration. Managing inventory (Econolink), managing store control and pharmacy (Pharmaserv) Financial services: Providing automated reconciliation and. reporting services, advanced payments, and offsets on receivables (Omnilink financial services) Warehouse administration: Supplying products to major retailers from 41- warehouses nationwide, providing warehouse management tools (Acumax Plus) Es CASE FOUR MCKESSON MAKES A DEAL ' Exhibit 3 Partial History of Acquisitions and Divestitures: McKesson Corporation without problems, it was generally acknowledged that the acquisitions had helped McKesson achieve the leadership position and competitive advantage it currently possessed. Two subsidiaries, Armor All Products Corporation and Millbrook Distribution Services, Inc, were sold off during the 19905 because they were not related to the health care mission (see Exhibit 3). Financial statements for McKesson are shown in Exhibit 4. The merger proposal before the board involved HBO and Co. (HBOC). HBOC was the lead- ing competitor in health care information, which was a high-growth segment of the informa- tion systems industry. HBOC provided software solutions and other technological innovations to the health E ' care industry (hospitals, physicians, HMOs). The company offered an array of integrated information programs to meet its clients’ demands for financial, clinical, home, and managed a Exhibit 4 Selected Financial Data: McKesson Corporation A. Income Statement (Doilars in millions, except per share data) Total SECTiON A CORPORATE GOVERNANCE, SOCIAL RESPONSIBILITY, AND ETHICS Six Months Ended Year Ended March 31, September 30, 1998 1997' 1996 1998 1997 Revenues $203573 $15,710.8 $12,964.51 $12,812.4 $10,122.6 Costs and expenses Cost of sales 19,3360 14,6735 12,049.3 11,981.4 9,390.1 Selling, distribution 7 _ _ and administration 1,159.1 ' ' 944.5 674.2 684.1 554.9 Inteifest ' _'102.;5. _ 5-5.7 _ . 44.4 57.4 48.1 Total line expenses 20597.6 _ _ 15,5797 12,767.9 12,722.9 9,993.1 1ncome (loss) before I ' ' ' - " income taxes and dividends on convertib1e - preferred- securities of' ' __ _.;'sub's'1_digry trust , 259.7' " (37.1 196.9 89.5 129.5 "income taxes . ' 93.5 " '31.;3 _ 76.2 34.9 49.2 ' Dividends on convertible ' preferred securities of . .Snb'sidiary' trust, net of . taxbenefit _ _ ' 1 (6.2) (0.7) —~ (311) (3.1) . Income (loss) after taxes '- ' _‘ ' . . ' - '—:-"-"_ ' Continuing operations 'I ' 15419131'1:'.'._2' S_.-1 . '- ' 120.7 51.5 77.2' -. Discontinued .- ' "' " ' I. .. ' ' ' ' . Operations (8) —..— -_-jl_'2_8_-.8 14.7 —_. 9w 2-. Extraordlnar}r item —~_ ' —' —— —. w '_Cumnl'ative effeet 61- _ _ _- . accountmg changes '—_—' , _ — 5— —~— -—» Net 1ncome _ '$ 1549 '$ 133.9 $ 135.4 5 51.5 $ 77.2 . D1111ted' earnings (loss) —' _.._-..._...._ —~"' —‘ "“— per common share -'."Cont1nu1ngoperz1tions ' $ 1.59 $ 0.06 $ 1.29 $ 0.51 $ 0.80 Discontinued ' ' . operations: —— 1.45 0.16 — —~ -. Extraordinary' lteni ... — — ~— —* ' Cumuiative effect of accounting changes . — _ _— --_—- — — Total -_ 1 1.59 $ 1.51 $ 1.45 $ 0.51 g 0.30 Diluted sha1es , 101.2 89.4 ' ' 93.2 7 106.2 ‘ 100.7 Basic. earnings (loss) per ' common share Continuing operations $ 1.69 $ 0.06 $ 1.36 $ 0.54 $ 0.85 Discontinued operefions _ -- 1.51 0.17 —-— ._ Extrao1dinery item — .__ —— — ~— Cumuiative effect of _ accounting Changes —— — —— ——_ —- $ 1-59 _§__1_-5.Z $_1-5.§ $ 0.54 w ‘___———__-_—‘ teammate-1n. ., .4. .. fmmrflrfmfimmfwrmmmwrwaism-“m: d'swm'xrmwl‘m Wfi’fffifff- :14 ma‘hstomtermgnse" . mammwmmwmm . Notes: The‘notes were deleted. Source: McKesson Corporation, SEC Form S-4/A, November 27. 1998 and www.sec.gov/Archives/edgarldata. care data. HBOC’s software applications were based On an open—architecture system; this- approach enabled customers to enhance their systems with HBOC software, regardless of the origins of their information systems. In addition to software applications, HBOC managed business offices, maintained information systems, and provided networking technologies and e-mail for many of its clients: The company numbered hospitals, pharmacies, laboratories, physicians’ offices, home care providers, and managed care providers among its 9,000 global customer-s. HBOC’S software products were complex and required up to 18 months to install. The company booked sales early in the installation process. Financial statements for HBOC are shown in Exhibit 5. The Health Care Industry The health care industry was very competitive and was changing rapidly. Competition in the industry, as in many others, compelled companies to deliver constantly increasing value to customers. Competitors believed the key to success was innovation to reduce costs, waste, and inefficiency. Technological change, they believed, could lead to dramatic and sustained improvements in price and service. The wholesale drug industry played a central role in the US. health care delivery system. Drug wholesaling was a growth industry, eitpanding as an aging population increased its con~ Sumption of pharmaceuticals. The industry was characterized by declining profit margins and the need for national distribution systems to supply an expanding base of drug retailers. Economies of scale were a prerequisite for survival. " “if SECTION A CORPORATE GOVERNANCE, SOCIAL RESPONSIBILITY, AND ETHICS The Propose. Exhibit 5 Selected Financial Data: HBO & Company {Dollar amounts in thousands, except per data) Note: Notes were deleted. Source: McKesson Corporation, SEC Form S-4IA, November 27, 1998 and wwwhooverscom. d Merger ' ‘ In the proposed merger, HBOC would become a wholly owned subsidiary of McKesson, and each share of HBOC’s common stock would be traded for a partial share (.37) of McKesson’s .' common stock. The exchange of stock would be tax free to stockholders for federal income tax purposes. ‘ ‘ If the merger was completed, 'FQEHTfi‘l’es-IWtfiWfifliiP‘resident and CEO of HBOC, would. become the Chairman of the board of directorsi'of McKesson HBOC,:‘Iifi‘fi'; and Mark Ar Puiido, President and CEO of McKesson, would serve as the board’s President and CEO. Following the merger, the board of directors would consist of 10 people, evenly split between former McKesson and HBOC directors. McKesson HBOC, Inc.’s bylaws would be written so that a three-fourths vote of the board would be required to replace either the Chairman or the CEO within the combined entity’s first year of operations. The Director’s Concerns Like most board members in large corporations, Lyle was a busy executive. A typical board member of a Fortune 500 firm has more than one directorate in addition to his or her own high-level, demanding executive position. Lyle was provided compensation and expenses for his work with the McKesson board of directors but primarily expected to see the value of his r stock appreciate as MEKéssomexpandedgitssppeseneein-health-cares CASE FOUR MCKESSON MAKES A DEAL '; Exhibit 6 Interests of Executive Officers in the Merger The executive officers of McKessonS: '. feéteiin the 'merger thatwere beyond ' ' rs.:I_n._the eVentJOffla-merger, ' 2' c‘Kesson's officers held. options sied-tor prices ranging from $22 75 to re options- could be exermsed . filcers purchased stoe en'- an - Lyle took seriously the oversight function of the board in corporate governance. Although he was protecting his own financial interests, he was also aware that he represented the inter- ests of many other stockholders, some of whom might be much more dependent on McKesson’s performance that he was. He knew that the protection that he had from personal liability for his decisions did not absolve him of responsibility for careful consideration of issues brought before the board. There was also the question of the financial interests of the executives involved (see Exhibit 6). Determined to fulfill his responsibilities, Lyle pondered the questions he should ask and how aggressive he should be in studying this proposal. McKesson’s mission of becoming “the world leader in health care supply management by assisting its customers in improving patient care while lowering or controlling costs” would be furthered by HBOC’s products and services. Health care information services was the missing link in McKesson’s overall strategy for dominating health care supply management. Lyle was also impressed by the possible syn— ergies from the proposed merger. The ability to market HBOC’s physician information prod- ucts to McKesson’s physician customer base was only one example of the two companies’ potential to share resources and activities. Both Bear Stearns and Co. (financial advisors) and Skadden, Arps, Slate, Meagher, and Flom LLC (legal advisors) had completed due diligence investigations and submitted reports favoring the merger. Could one director have insight beyond that of a staff of attorneys? Pulido, McKesson’s CEO, had told Lyle that Pulido thought the merger would result in a unified organization with several advantages: a deep and talented pool of managers, the capa- bility of becoming a world leader in the supply of health care products and services, the ability to increase revenues by cross-marketing each other’s products, and the capacity to reduce expenses by eliminating redundant personnel and facilities. + % it P“ M U? 0A l’ 754% SECTION A CORPORATE GOVERNANCE. SOCEAL RESPONSIBILITY, AND ETHICS Lyle, however, was concerned. Synergies anticipated from past mergers had not always materialized. He sometimes worried about whether the directors and managers of acquired companies had the same loyalty, ethics, and concern for stockholders that he did. He was also concerned about his fiduciary responsibility to other shareholders under agency law. He was not sure that mergers were always equally advantageous for each firm’s stockholders. ...
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