‘Stepping Up’ to Make a Strategic Acquisition

Express Scripts likely will grab a basis "step-up" tax break when it finalizes the acquisition of two Wellpoint subsidiaries. The move may have allowed Express Scripts to offer a bigger premium to Wellpoint.

Pharmacy benefits management company Express Scripts Inc. signed a definitive agreement last month with WellPoint Inc., under which Express Scripts will acquire Wellpoint’s “NextRx subsidiaries” for $4.675 billion — an amount which includes consideration “for the value of a future tax benefit for Express Scripts based on the structure of the transaction.” But what future tax benefit are they referring to?

Indeed, Wellpoint (through subsidiaries) will be selling the sole membership interest in a limited liability company, namely Next RX LLC, to Express Scripts. For tax purposes, Next Rx is a “disregarded entity” and Wellpoint will also be selling 100 percent of the stock of each of Next Rx Inc. and Next Rx Services Inc.

The consideration for the LLC interest totals $3.553 billion which will be delivered in the form of $2.489 billion in cash and the remainder in shares of common stock of Express Scripts. Deal considerations will be distributed in the following manner: For Next Rx Inc., Wellpoint will receive $841.5 million, of which $589 million will be in the form of cash and the remainder in shares of Express Script common stock; for Next Rx Services Inc., Wellpoint will receive $280.5 million, of which $196 million will be in the form of cash supplemented by $84.5 million in shares of Express Script common stock.

Therefore, in the aggregate, some 70 percent of the consideration conveyed by Express Scripts to Wellpoint will be in cash, and the remainder of the consideration will be comprised of Express Scripts newly-issued common stock.

Cost Basis 

The agreement provides that, (1) the parties will treat the purchase by Express Scripts of the LLC interest as a purchase of assets, and (2) Express Scripts and Wellpoint will jointly “complete and make” an election under the tax code — specifically Section 338(h)(10) — with respect to Next Rx Inc. and Next Rx Services Inc. Making such an election under Section 338 allows for certain tax benefits related to the recognition of gains and losses.

Bob Willens 2Here, as in most Section 338(h)(10) situations, a portion of the benefit will be “shared” with the seller in the form of a higher purchase price for the properties. — Robert Willens.

For instance, Express Scripts will secure a cost basis in the assets acquired, and in the process gain access to the benefits of Section 197(a) of the tax code, the provision related to the amortization of goodwill and other intangible assets. That means that the amounts paid for the intangible assets obtained in the acquisition, most notably customer lists and similar “customer based intangibles,” will be amortized over a 15-year period with the result that Express Scripts’s taxable income, and therefore its cash tax obligations, will be markedly reduced. Here’s how the tax code works in this instance:

An election under Section 338(h)(10) may be made for a target company if a corporation acquires enough of the target’s stock to meet the requirements of Section 1504(a)(2) — which is 80% — and is selling a consolidated group in a “qualified stock purchase.”


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