Caremark on edge of auction law

By Jessica Hall

PHILADELPHIA, Feb 15 (Reuters) - Caremark Rx Inc. CMX.N may be within its rights to refuse to talk to hostile suitor and rival Express Scripts Inc. (ESRX.O), but merger experts say its stance runs afoul of good corporate governance practices.

Caremark, which manages pharmacy benefits for corporations, has maintained that its $24.2 billion deal to be acquired by drugstore chain CVS Corp. (CVS.N) would bring more value to shareholders than Express Scripts' $27.2 billion bid.

The company has also said the Express Scripts offer contains too many conditions, as well as the antitrust risks of combining two competitors. Express Scripts has pressed ahead, though, forcing CVS to twice sweeten its bid.

Now experts wonder whether Caremark is more committed to its vision of the CVS merger creating "a powerful force for change in pharmacy services" than to getting the best deal.

"The sole obligation of a director is to get the highest possible price for their shareholders," said Charles Elson, chairman of the Center for Corporate Governance at the University of Delaware.

"Once another bidder has emerged," he added, "it's their obligation to open communication with them and explore that opportunity."

Caremark noted that the value of the CVS transaction had increased by $2.6 billion in cash since it was first proposed in November.

The deal was "the result of a thorough and thoughtful board process that continues to focus on protecting the best interests of, and creating value for, the Caremark shareholders," Caremark said.

Before the most recent increase in CVS's offer, several influential proxy advisory firms said Caremark shareholders should reject the deal. Institutional Shareholder Services this week slammed Caremark's board for failing to talk with Express Scripts, saying conditions of the Caremark-CVS pact, such as a "force the vote" clause, did not comply with current M&A best practices.

"Based on the risky strategic rationale, the nil-premium offer price, the initial poor market reaction, and the change-in-control benefits to insiders, we cannot fathom why the (Caremark) board did not ... commence nonbinding negotiations with (Express Scripts) after it had submitted its unsolicited offer," ISS said.

This week, CVS raised its bid for the second time by increasing a special, one-time dividend, but it is still offering less than Express Scripts -- and Caremark's current stock price of $64.25. CVS's offer is valued at about $61.48 per share, including the $6 dividend, and the Express Scripts bid is valued at $62.37.

Express Scripts has asked Delaware's Court of Chancery to void the $675 million breakup fee in the Caremark-CVS pact. A hearing is set for Friday.

The breakup fee and other provisions in the merger agreement "have virtually guaranteed that the Caremark board cannot properly exercise its fiduciary duties if a competing bid emerges," the lawsuit said.

This week the court ordered Caremark to push back its shareholder meeting on the CVS deal until at least March 9 from Feb. 20 so shareholder could review the new terms.

MIXED MESSAGES

A review of merger cases gives Caremark mixed odds of success in defending its position, lawyers and investment bankers said.

The Delaware courts have ruled that NCS Healthcare Inc.'s deal to be acquired by Genesis Health Ventures contained restrictions that kept the company from accepting a superior offer. Omnicare Inc. (OCR.N) challenged the agreement and won on appeal; it acquired NCS in 2003.

To protect shareholders, the board of a target company needs to be able to consider a better offer, explained Allen Michel, a professor at Boston University's School of Management.

Delaware's Chancery Court has already rebuked Caremark.

On Tuesday, Judge William Chandler said shareholders voting on the CVS deal should consider that Caremark had weighed potential transactions with Express Scripts on at least three separate occasions in previous years.

That disclosure is particularly stunning, Chandler said, considering Caremark has said a deal with Express Scripts carried such grave potential antitrust risks that it prevented the board from even considering their offer.

In another famous merger case, this one involving cosmetics maker Revlon Inc. (REV.N), the courts established that if a board concludes that a company's sale is inevitable, the directors must be neutral arbiters to ensure that shareholders get the best possible offer.

Caremark has argued that this case does not apply since the company was not formally up for sale. As a result, it has said it did not have to conduct a full-fledged auction.

ISS agreed, but added: "It's difficult to see the harm in entering discussions with (Express Scripts) to see if a better deal was achievable."

MONEY TALKS

From a shareholders' point of view, do legal semantics matter?

"Revlon is an interesting legal question, but from your shareholders' point of view, they want the best price at the end of the day," Elson said.

"If you told shareholders that 'I want to represent you on the board, but in the event of a merger I'm going to stand behind Revlon rules and not take the highest offer' -- chances are you wouldn't get re-elected," Elson said.

Still, perhaps Caremark has been a savvy negotiator.

Equity Office Properties recently won praise for running a successful auction. It opened talks with unsolicited bidder Vornado Realty Trust (VNO.N) and ultimately forced its original suitor, private equity firm Blackstone Group, to raise its bid.

The $23 billion Blackstone eventually agreed to pay is a 24 percent premium over Equity Office's stock price on Nov. 17 -- the last trading day before the firm's initial offer of $20 billion.

The premiums are even bigger for Caremark. CVS's offer is 25 percent higher than Caremark's stock price on Oct. 31 -- the day before news reports of the drugstore chain's interest in the company surfaced -- while Express Scripts' bid carries a 27 percent premium.

((Editing by Lisa Von Ahn; jessica.hall@reuters.com; 215-922-1086)) Keywords: COLUMN MERGERS/

(C) Reuters 2007. All rights reserved. Republication or redistribution ofReuters content, including by caching, framing or similar means, is expresslyprohibited without the prior written consent of Reuters. Reuters and the Reuterssphere logo are registered trademarks and trademarks of the Reuters group ofcompanies around the world.nN15357560