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Cashing in on the U.S. drug craze Add to ...

It wasn't a great time to go looking for capital. The tech bubble had just burst, sending the shares of network giants like Nortel into free fall. Nonetheless, the SXC offering found its way to Toronto's Covington Capital, a venture capital firm that was prepared to take the long view. "From an investment strategy perspective," recounts Jeff Park, a former Covington partner who has since become SXC's CFO, "it had a good management team, with U.S. health care experience, strong reference clients and a growing annuity stream." Covington kicked the tires and bought a 35% stake for $6 million, as part of a $13-million round of financing. Park took a seat on the board.

By early this year, Covington-with $225 million in assets invested in a range of tech, pharmaceutical and health care firms-had sold most of its initial SXC stake for $85 million. It was a brilliantly timed divestiture that earned it Canada's Venture Capital & Private Equity Association's 2010 deal-of-the-year award. Thirteen-fold returns, after all, don't come along every day.

SXC's transformation dates back to a 2005 decision by CEO Gordon Glenn and SXC's board. As Jeff Park tells it, the company's technology was in wide use among PBMs, which were buying it on a per-transaction basis. By then, SXC had bought ComCoTec, and one of its executives, John Romza, was leading the combined company's technology division. PBM customers were constantly asking him to add new features, depending on each plan's needs. "Selling services that use those tools is a natural extension," he says.

The decision to morph into a full-service PBM generated some controversy internally, since it meant that SXC might end up competing with its own customers. "There was some concern, and rightly so," says Glenn. To quell unrest, the firm pledged to create internal firewalls so the new PBM division couldn't use proprietary data from its IT customers.

To oversee the transformation, the board reached deep into the PBM industry and hired Mark Thierer to step in as president and COO. Soon, he took over from Glenn, who retired to his home in Florida. Park, meanwhile, quit the board and moved to Chicago to take over as CFO.

Thierer is an all-American executive right out of central casting: The Iowa-born MBA is friendly, with a dash of brash-and he's highly motivated to kick his competitors' butts. He has spent more than 25 years in the health technology field, first with IBM and later in a variety of senior gigs at Caremark. In 2003, he left Caremark to join Allscripts, whose technology, among other things, helps physicians and health plan managers ensure that their patients are filling their prescriptions (unfilled scrips cost American drug companies $50 billion U.S. in foregone revenues every year).

Thierer arrived at SXC just as a growing number of PBMs were being hit with lawsuits launched by independent pharmacists and plan sponsors. At issue was a lack of transparency in their pricing strategies. Typically, PBMs had negotiated bulk discounts from the drug companies, but didn't pass on all the savings to plan sponsors and their members. What's more, these firms often hid the true price of individual drugs, applying hefty markups on widely used generics to offset more costly or less popular brand names. Most PBMs also set up mail-order services to undercut bricks-and-mortar pharmacies with discounted dispensing fees that further boosted their margins.

As Thierer built the upstart PBM operation, he decided to let customers know exactly how much SXC was paying for individual drugs. The upshot: The sponsors could price their benefits packages more effectively and contain costs. "It was about providing clarity about what you buy and sell drugs for," he says.

By late 2007, however, Thierer and the board decided they weren't satisfied with the pace of change. They'd won a few clients, but wanted to accelerate the transformation. After all, SXC was still a tech shop; it needed to radically change its culture. The board did a "build or buy" analysis and opted for the latter. "It would get us there so much more quickly than building the PBM division brick by brick," says Thierer. "It was all about speed to market, and scale."

In February, 2008, SXC spent $143 million (U.S.) to acquire National Medical Health Card Systems (NMHC), a Long Island PBM that had been one of SXC's technology customers. Suddenly, they had a roster of 350 health plan clients, a pharmacy sales network and the heft they required to reinvent themselves. Before the deal, SXC's nascent PBM group had been handling drug benefits for about 1.5 million people. The NMHC deal added another 2.3 million virtually overnight. As Phil Reddon, a Covington managing partner who took over Jeff Park's place on the SXC board, says, the deal was "transformational."



Some SXC watchers, however, initially didn't pay much heed to the acquisition. It didn't involve large sums of cash or a well-known player. Indeed, the stock lost $1.64 on news of the announcement (it trades on both the TSX and Nasdaq). But that indifference was an advantage. Thierer's first order of business was to combine the two firms, a project that included no fewer than 19,000 integration tasks. To get it done, Thierer brought in a corporate SWAT team-about two dozen PBM veterans, many of whom he knew from his days at Caremark-and ordered them to floor it.

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