Part 1: Strategic and Market Analysis
Part 2: Antitrust Issues
Part 3: Second-Order Effects on Wholesalers, Other PBMs, and Walgreens (Hint: you’re reading it right now!)
Today, I look at how the merger could affect other players in the channel. My observations:
- The deal could be a blessing in disguise for AmerisourceBergen (NYSE:ABC), although the conventional wisdom favoring Cardinal Health (NYSE:CAH) is probably correct.
- Mid-market PBMs—Catalyst Health Solutions (NASDAQ:CHSI), SXC Health Solutions (NASDAQ:SXCI), and Prime Therapeutics—have big new growth opportunities.
- Expect a quick resolution to the Express Scripts-Walgreens (NYSE:WAG) dispute due to Walgreens’ enhanced negotiating position following the merger announcement. I wonder if Express Scripts has figured this out yet?
Right now, the conventional wisdom suggests that CAH will absorb the combined ESRX-MHS mail contract as the incumbent supplier, which was probably what triggered the drop in ABC’s stock price when the deal was announced. Keep in mind that many of ABC’s specialty subsidiaries compete head-to-head with various businesses of Express Scripts, so any partnership would be awkward (especially for new CEO Steve Collis).
Don’t count ABC out. They have more to lose given Medco’s share of their business, as I show in the chart in What’s Next for AmerisourceBergen. I also perceive that Medco has a better deal from ABC than ESRX has from Cardinal.
Here’s a radical alternative scenario. A combined ESRX-MHS contract would squeeze even more blood from the wholesalers. Perhaps Steve Collis will be bold and voluntarily walk away from a marginal deal in favor of ABC’s historical focus on smaller customers with higher-service needs. Can Collis sell the “smaller, more focused, and more profitable wholesaler” story to Wall Street?
By way of background:
- Large PBM mail-order pharmacies purchase traditional (non-specialty) brand-name drugs primarily via a wholesaler. ABC’s current 5-year agreement with Medco expires in March 2013. Cardinal Health’s contract with Express Scripts reportedly expires in June 2012.
- Mail pharmacies pay less when buying brand-name drugs from the wholesaler than they do when buying directly from the manufacturer. To understand why, read “Relationships with Pharmaceutical Wholesalers” in The 2010-11 Economic Report on Retail and Specialty Pharmacies.
- These mega-customers are minimally profitable for a wholesaler, but do provide other financial benefits. (See pages 24-29 of The 2010-11 Economic Report on Pharmaceutical Wholesalers.) Wall Street analysts estimate earnings-per-share loss to ABC of $0.06 to $0.20 if the Medco contract moves to Cardinal, but it wouldn't happen for a couple of years.
The deal opens up a new sets of opportunities for mid-market PBMs such as CatalystRx (NASDAQ:CHSI) or SXC’s InformedRx (NASDAQ:SXCI).
SXC management claims to be the technology backend for one-third of the regional PBMs, so the task of rolling them up would be pretty easy. SXC has a more than $300 million of cash, so expect deals to start happening fairly soon.
Catalyst is busy digesting its purchase of Walgreens Health Initiatives. See SOLD! Thoughts on the Catalyst-Walgreen Deal. But according to Eugene Goldenberg at BB&T Capital markets, Catalyst has already identified two captive PBMs that are expected to come to market this fall and intends to make a run at either and/or both opportunities with an estimated purchase price of $200M-$400M.
Prime Therapeutics just became more attractive to other Blues plans that aren't in the club. Here’s a summary of the PBMs servicing Blue Cross Blue Shield plans based on data published in May by Larry Marsh at Barclays Capital. Happy hunting!
- Express Scripts: 20 plans / 23.3 million covered lives
- Prime: 9 plans / 14.5 million covered lives
- Medco: 6 plans / 12.0 million covered lives
- CVS Caremark: 7 plans / 9.2 million covered lives
- Catalyst: 2 plans / 2.2 million covered lives
The conventional wisdom suggests that this deal puts more pressure on Walgreen to resolve its dispute with Express Scripts. See Walgreen and Express Scripts Play Chicken for background. In theory, Walgreen is now more anxious to settle with a PBM handling 40%+ of its business (per the pro forma estimates in ESRX-MHS: Strategic and Market Analysis).
I disagree. As I see it, Walgreens has gained power with the merger announcement. Consider the following alternative scenario:
- The merger, even if its clears the antitrust hurdle, probably won’t close until early 2012. Thus, both Express Scripts and Medco need to keep selling through at least the current selling season during the FTC uncertainty.
- CVS and Walgreen are more than 25% of all retail pharmacy locations in the U.S. Even if Express Scripts could sell a network without Walgreen, there’s just no way they could be competitive with plan sponsors unless CVS is also in the network.
- If Express Scripts doesn't wrap up the Walgreens situation quickly, both Express Scripts and Medco will be very vulnerable to noise from CVS’ retail pharmacy business. Imagine if CVS made ripples about being unhappy with its PBM network contract with either Express Scripts or Medco? Sister company Caremark would sure be happy.
That’s all for now, folks. I’ll return to regularly scheduled programming soon, but of course will continue checking in on the deal’s progress as news breaks.
In the meantime, please leave your own comments and thoughts below. Comment anonymously if you must.