$2.16 billion boost

For those who still needed convincing, McKesson Corp. recently provided $2.16 billion worth of evidence illustrating how the healthcare industry is driving the nation's economy.

That's how much money the San Francisco-based pharmaceutical and information technology mega-company is spending to acquire US Oncology. Based in the Woodlands, a Houston suburb, US Oncology boasts more than 1,300 affiliated physicians providing care for 700,000 cancer patients at 496 locations in 2009.

Observers are wondering if there will be a culture clash with McKesson entering the provider arena. But during a Nov. 1 conference call with investors, McKesson CEO John Hammergren said the company plans to continue the US Oncology business model of affiliating with, rather than employing, the physicians in its workforce.

“We do not plan to ever own providers,” Hammergren said.

At least one US Oncology physician, Nicholas Vogelzang, chair and medical director of Comprehensive Cancer Centers of Nevada, noted how he expects the deal to help him maintain an independent practice.

“The US Oncology model is hospital-independent—this allows us to stay that way for a long time,” Vogelzang said.

In addition to benefitting from McKesson's pharmaceutical distribution prowess, Vogelzang said, doctors in the US Oncology network are expecting McKesson to upgrade US Oncology's iKnowMed cancer-care electronic health record. He said it provides strong analytical and decision-support tools but also can slow workflow with it “clunky” data-entry procedures.

Under terms of the deal, which is expected to close by Dec. 31, McKesson will assume US Oncology's outstanding debt of some $1.6 billion and will acquire about $155 million in tax credits from operating losses “to be used in the future by McKesson,” Hammergren said during the conference call. McKesson declined to provide a representative to be interviewed for this article.

Hammergren said McKesson will pay “$400 million or so in cash off the balance sheet” and add about $1.7 billion to its own existing debt—first in the form of a short-term bridge loan and then some form of permanent financing. He added that the deal is being done at time that is typically the low point in the company's cash cycle—but “in no way taps out our ability to deploy capital.” McKesson's growth and financial strategies of portfolio expansion and stock repurchasing are expected to continue, he said.

“The acquisition makes great financial sense for our shareholders and will be a source of earnings growth almost immediately,” Hammergren said.

US Oncology will come under McKesson's Specialty Care Solutions business, which will now be based in the Woodlands and be led by US Oncology President and CEO Bruce Broussard, who will report to Paul Julian, McKesson's executive vice president and group president. Because of this arrangement, Roy Beveridge, US Oncology executive vice president and medical director, said there will be no culture clash between the two companies' respective workforces.

“What's happening is that McKesson has a great number of oncology assets, and US Oncology is staying in Houston, Texas, and a lot of these assets are moving from San Francisco to Houston,” Beveridge said. He noted that employees and affiliates of US Oncology will still work for the same CEO, and the company name also is staying the same. “So, the culture will remain that of US Oncology.”

The deal, which coincided with the release of US Oncology's third-quarter earnings report, also has spotlighted cancer-care statistics. It's expected that there will be almost 1.5 million newly diagnosed cancer patients in 2010, Hammergren said, adding that men have a 1-in-2 chance of getting cancer in their lifetimes, while women have a 1-in-3 chance.

“The National Institutes of Health estimates that total cancer costs are $264 billion annually; and, of that, $103 billion is direct medical cost,” Hammergren said. “In response to this, the pharmaceutical industry has a robust pipeline of over 800 new cancer drugs and new indications for existing cancer drugs in development. This number of drugs is far greater than any other therapeutic category.”

“As a result of this reality, demand for oncology services is increasing rapidly,” he said, adding that US Oncology's network of affiliated physicians in 38 states currently treats 17% of all U.S. cancer patients.

US Oncology is owned by the New York-based private-equity firm of Welsh, Carson, Anderson & Stowe. Hammergren noted in the conference call that the financial strength of the company was not lost on its owners, but explained that it's the nature of private-equity investments “to be turned or harvested at some point.”

“I don't think the sellers were oblivious to the opportunities for continued growth,” he said.

In its assessment of the transaction, Citi Investment Research & Analysis noted how McKesson is a “distant second” in specialty product distribution with 16% of the market, compared with AmerisourceBergen Corp.'s 55%.

The acquisition should allow McKesson “to further penetrate the rapidly growing specialty space and partly close the gap between itself and its largest specialty rival with approximately 25% market share,” the Citi analysis stated, adding that the deal is complementary to McKesson's 2007 purchase of the Oncology Therapeutics Network Corp.

During US Oncology's own conference call detailing both the deal and its third-quarter financial report, David Young, senior vice president and interim chief financial officer, noted that the key drivers in his company's expansion are patient growth and physician growth.

According to its third-quarter earnings report, released Nov. 4, US Oncology brought in its highest-ever quarterly number of new physicians: 82. The report also noted that the number of new cancer patients it saw per day increased to 633 from 624 in the third quarter of 2009; but total patient visits decreased to 11,735 from 11,838. Visits for radiation treatments and diagnostic scans dropped to 3,614 from 3,850 for the same period.

In the conference call, Broussard said these decreases were seen in June, July and August, with patient volumes picking up again in September, and Young said the growth in September was expected to continue into the fourth quarter.

The report states that the company continues to believe it is “well-positioned throughout healthcare reform,” but “We also continue to believe that increased government spending required by the legislation, coupled with existing and growing federal budget deficits, will create future reimbursement pressures on providers as the government attempts to slow spending increases in healthcare and other entitlement programs.”

It concluded that the healthcare reform law “is neutral to positive for US Oncology.” The legislation's creation of accountable care organizations will result in increased competition from hospital cancer programs, and the law's “failure to substantially address intensifying systemic cost and financing issues” created further pressure on the company to implement is own cost-reduction strategies, the report said.

Mark Dubow, a senior vice president with healthcare management consultants Camden Group, said the merger could result in significant growth and cost-cutting on both sides of the deal.

“If I was McKesson and I run a multibillion-dollar business based on drug distribution, how else do I ensure my place, grow my business and position myself to take advantage of broader industry trends?” Dubow asked. Conversely, he added that aligning with a corporation that runs a group purchasing organization specific to oncology drugs would be one way to lower costs to patients.

While hospital-based ACOs may create competition for US Oncology, Beveridge noted that the company already has some 20 joint ventures with hospitals,

Vogelzang described iKnowMed as one of US Oncology's 26 business lines, and Beveridge said it's one that he expects to see growth after merging with McKesson.

“We're not a software development company, we're not a systems development company, but we believe McKesson is superlative in those developmental areas,” he said. “We have to believe that, by aligning with them, that our aspirations from an IT standpoint will be dramatically improved.”