McKesson Corp.’s Plan to Buy Businesses from Katz Group Canada Is Credit Positive

McKesson Corp.’s Plan to Buy Businesses from Katz Group Canada Is Credit Positive

Last Monday, McKesson Corporation (Baa2 stable) said it plans to acquire the independent banner and franchise businesses of drugstore operator Katz Group Canada Inc. (unrated) for CAD920 million ($922 million). The deal is credit positive for McKesson because the company is using offshore cash, rather than debt, to acquire a business that will add EBITDA and expand its reach with independent pharmacy customers in Canada.
Approximately $2.0 billion of McKesson’s $4.2 billion of total cash was outside the US at the end of 2011. We look favorably on companies that are able to use non-US cash for EBITDA-enhancing transactions. The cash might otherwise sit on their balance sheets if they choose not to move profits generated outside the US back to the US and take the associated tax hit.

McKesson’s EBITDA was close to $3 billion for the 12 months that ended on 30 December 2011. Based on management’s guidance on accretion to earnings, we estimate the Katz acquisition will add $38-$77 million in EBITDA during the first year following the close of the transaction. McKesson said it expects the acquisition to close in the first half of 2012, subject to regulatory approvals.
The acquisition of the Katz businesses will also allow McKesson to market more services, including specialty pharmaceutical services, to independent drugstores, which we believe offer higher margins than larger customers. Smaller customers typically have less pricing power and require a broader range of services.

Katz’s independent banner business, which operates under the name of Drug Trading Company Limited, provides marketing and purchasing services to a network of about 850 independently owned Canadian pharmacies, most of which operate under the I.D.A. and Guardian names. Medicine Shoppe Canada Inc., Katz’s franchise business, provides services to approximately 160 independent Canadian pharmacies. McKesson already operates banner groups in Canada, including Proxim, Associated Retail Pharmacy and Family Health Care Pharmacy. McKesson said the member-pharmacists will remain owners of their pharmacies and continue to manage their businesses.

McKesson’s Canadian pharmaceutical distribution business contributed about 9% of more than $90 billion in total revenues for the nine months ended 30 December 2011.
McKesson faces challenges in Canada. We expect the company’s Canadian distribution revenues, which saw negative constant currency growth in the third quarter of fiscal 2012, to remain under pressure because of government price constraints on generic drugs.