Tuesday, July 26, 2011

ESRX-MHS: Antitrust Issues (2 of 3)

Welcome to Part 2 of my musings about the merger of Express Scripts (NASDAQ:ESRX) and Medco Health Solutions (NYSE:MHS). Here's the schedule:

Part 1: Strategic and Market Analysis (yesterday)
Part 2: Antitrust Issues (today)
Part 3: Second-Order Effects on Wholesalers, Other PBMs, and Walgreen (tomorrow)

Right now, I give the deal a 60% chance of being approved by the Federal Trade Commission. It’s going to be a very tough fight for antitrust approval, but perhaps not for the reasons you think.

The Agreement and Plan of Merger filed on Friday gives us a peek at the companies’ strategy for clearing the antitrust hurdles. But note that there is no termination fee if the companies don’t get antitrust clearance.

As I mentioned yesterday, I can only scratch the surface of the antitrust analysis on Drug Channels. Pembroke Consulting clients and Gerson Lehrman Group clients should feel free to schedule phone calls with me for additional comments beyond what I discuss below.


The Horizontal Merger Guidelines (HMG) document published by the Federal Trade Commission (FTC) and Department of Justice (DOJ) provides a nice, concise overview of how the agencies will review the deal.

There's no doubt that the ESRX-MHS merger will get a lot of scrutiny because of the projected increase in the Herfindahl–Hirschman Index (HHI). (See page 19 of the HMG.) However, an HHI analysis is not sufficient to conclude that the merger will or will not succeed, as I discuss below.

If the HMG is too wonky, then the FTC has a fun (?) online cartoon that explains "how competition helps you get more for your buck at the mall". Actual, no-kidding, screen grab below. Can't wait to share this site with my kids when they get back from summer camp!


The NCPA came out slinging mud in Pharmacists: Proposed Express Scripts-Medco Merger Would Reduce Competition and Raise Health Care Costs. Ironically, they encouraged the FTC to block the deal on anti-competitive grounds while simultaneously arguing in favor of legislation that would waive anti-trust laws so pharmacies could collude. Whatever.

NACDS joined NCPA in issuing a joint statement in NCPA, NACDS Issue Joint Statement to Oppose Express Scripts, Medco Deal: “Too Big To Play Fair”, stating that: “This combination will monopolize control of the supply line for brand and generic drugs…”

Alas, their complaints about "monopoly power" are misguided when describing the relationship between a PBM and pharmacies, manufacturers, or wholesalers. These organizations are not customers of a PBM in the context of the supply chain. They are sellers of goods or services. See the chart in my Strategic and Market Analysis post.

Forgive my economics geekiness, but the appropriate word here is oligopsony—a market in which there are many sellers but few buyers. Sellers in a oligopsonistic market are understandably concerned about their own self-interest when market power becomes more concentrated with fewer, larger buyers.

The FTC recognizes that an oligopsonistic market structure can be pro-competitive and favorable for customers, as the agency pointed out in its statement on the Caremark/Advance PCS deal:
"We also considered whether the proposed acquisition would confer monopsony (or oligopsony) power on PBMs when they negotiate dispensing fees with retail pharmacies. It is important not to equate market concentration on the buyer side with this kind of power. For example, a shift in purchases from an existing source to a lower-cost, more efficient source is not an exercise of monopsony power. Nor do competition and consumers suffer when the increased bargaining power of large buyers allows them to obtain lower input prices without decreasing overall input purchases. This bargaining power is procompetitive when it allows the buyer to reduce its costs and decrease prices to its customers."
Pharmaceutical manufacturers and pharmacies won't like this reasoning, but shouldn't be surprised when the FTC brings it up. (BTW, don't shoot the messenger, OK?)


The real antitrust questions for the FTC will derive from potential market power issues facing customers of a PBM—the plan sponsors or third-party payers.

The key question: Will competition remain strong enough to ensure that a portion of any cost savings (from bargaining power or efficiencies) get passed through to plan sponsors?

National market share is less relevant given the competitive dynamics of the PBM industry, which is why I am skeptical of the Herfindahl–Hirschman Index (HHI) analyses being put forth by Wall Street analysts.

Instead, I expect the FTC to examine the key question above on a market-by-market basis. The FTC is likely to look separately at the large employer/plan market, regional health plans, mid-market employers, and other PBM client markets.

A few representative questions should give you the flavor of their inquiries:
  • Will there be enough competition for the business of large employers and large health plans with only two large PBMs?
  • Will health plans view in-house PBMs as a more viable option (such as Cigna and Humana)?
  • Will health plans be willing and able to create new jointly-owned PBMs (such as the Blues did with Prime Therapeutics)?
  • Will OptumRx or Prime Therapeutics use the merger as an opportunity to go beyond their in-house customers and compete for the big deals as a third option?
  • Will the mid-market PBMs step up to the next-level opportunities?
I haven’t seen any official public statements from PBM customer associations such as AHIP or BCBSA, but it’s still early in the game. If these type of groups vigorously oppose the deal, then it's unlikely to be approved.

FYI, I'll talk more about the other PBMs in tomorrow's post.


The companies certainly don’t view FTC approval as a slam dunk. For one thing, there's no termination fee linked to the failure to get antitrust approval.

Section 5.8(e) (page 68) of the Agreement and Plan of Merger lays out the steps that Express Scripts has already agreed to take to get the deal through the FTC:
  • Divest or dispose of one mail order dispensing facility (except the Express Scripts facility in St. Louis, MO)
  • Divest or dispose of a specialty pharmacy or infusion facility having a net book value less than $30 million (except the Express Scripts facility in Indianapolis, IN)
  • Dump contracts with collective EBITDA less than $115 million in the previous 12 months (as long as these contracts have less than 35 million adjusted prescription claims in aggregate)
In the meantime, don’t be surprised if another bidder jumps into the fray—a scenario that is explicitly contemplated in the deal document.


  1. Can you elaborate on the third bullet point above......."dump any contracts with EBITDA less than $115 million in  the previous 12 months (as long as these contracts have less than 35 million adjusted prescription claims in aggregate)"?

    What kind of contracts are these.........can you give an example?

  2. Here is the verbatim language from section 5.8(e) of the Agreement and Plan of Merger:

    "(3) the divestiture, disposition,
    termination, expiration, assignment, delegation, novation or transfer of Contracts of Aristotle,
    Plato or their respective Subsidiaries which generated, collectively, EBITDA not in excess of $115
    million during the most recently available twelve (12) calendar month period ending on the
    applicable date of such agreement relating to such divestiture, disposition, termination,
    expiration, assignment, delegation, novation or transfer; provided, however, with respect to this
    subclause (3), in no event shall, in the case of pharmacy benefits management customer Contracts of
    Aristotle, Plato or their respective Subsidiaries, the aggregate annual number of adjusted
    prescription drug claims subject to the foregoing obligation exceed 35 million (where “adjusted
    prescription drug claims” means (x) retail prescription drug claims, plus the product of (y)(i)
    mail prescription drug claims multiplied by (ii) three (3), such calculation to be performed using
    claims made during the preceding twelve (12) calendar month period);"

    For comparison, Express Scripts' EBITDA in 2010 was $2.3 billion (5.1% of revenues).


  3. Adam,

    Great analysis!  Just curious, who do you think the other bidders for Medco could be?


  4. AnnonymousJuly 26, 2011

    I seem to recall that health care reform allows for the creation of an FDA framework for the approval of biosimilars. Any idea what the potential upside of this would be on the merged company?

  5. 1040anonymousJuly 26, 2011

    Adam, I have a slightly different interpretation or your bullet point 3 above. ('Dump any contracts with EBITDA less than $115 million in the previous 12 months (as long as these contracts have less than 35 million adjusted prescription claims in aggregate)). Did you mean to say contracts TOTALLING UP TO $115 million in EBITDA?  - as opposed to ANY contracts with EBITDA less than $115 million? In other words, they are willing to give up small accounts adding up to $115 million EBITDA.

  6. Yes, it is contracts totaling up to $115 million. I'll put a comment in the post to clarify. Thanks for pointing this out.

  7. Correct, the PPACA authorizes a new regulatory pathway. Biosimilars are a long-term opportunity for PBMs.

    I expect competition between the innovator biologic and the biosimilar (follow-on biologic) to resemble brand-to-brand competition rather than brand-generic competition, i.e., no automatic substitution of biosimilar for innovator biologic. Thus, the PBMs can apply their rebate/formulary models.

    Bigger share of specialty would help, but the timing is so uncertain that I'm not sure it really has a near-term (or even medium term) impact on this deal.

  8. I'd prefer not speculate on the site, but don't forget that there could even be a bidder for ESRX.

  9. Adam, what are your views on the concentration of the mail order pharmacy and specialty pharmacy industries, and the impact that this deal might have on competition in those markets?

  10. WAG has much cleaner and more robust balance sheet than ESRX.  If CVS bought Caremark, I don't see why WAG can't buy MHS.

    They can easily outbid ESRX, not only because they're much larger with healthier finance, but also they have higher credit ratings and will be able to take out loans and lower interest rate.

    WAG+MHS probably has lower regulatory hurdle due to recent precedent, and it's a good way for WAG to get out of its current bind.

  11. Walgreens would have a tough time convincing investors to let them buy ESRX or MHS. WAG sold their PBM and then told investors in March that there is an "inherent conflict" in owning a PBM. See Walgreen Talks PBM Conflicts, 90-Day Rx Profits, and AMP.

  12. Ah I remember this post. :-)   You are probably right.  But a lot has happened since.  I guess Wasson can call it a divestiture of non-core asset, because their PBM accounted for a small fraction of their business.

    But if it was worth $10 billion instead of the paltry $500million they got for it, do you think would've sold it?

  13. A concerned pharmacy ownerJuly 27, 2011

    Dr. Fein,

    Thank you for publishing all of this information on your website. I don't agree with your views on indepenent pharmacies but respect your knowledge and willingness to provide your ideas.

    I want to know what you think about the FTC's treatment of pharmacies. I read the Caremark letter and was SHOCKED. This is the last sentance: "Although retail pharmacies might be concerned about this outcome, a reduction in dispensing fees following the merger could benefit consumers."

    How will putting pharmacies out of business by reducing our low dispensing fees "benefit consumers"?? This is OUTRAGEOUS!! I hope other owners open their eyes to what's going on and demand better treatment for those of us on the front lines of healthcare.

    Do you think this is right, Dr. Fein?

    Thank you for your time and consideration.

  14. Great article!  Has your feelings changed regarding the probability of deal going through?  Also, are you surprised that Walgreen and Express Scripts still haven't settled their differences?

  15. I have been very surprised that the ESRX-WAG dispute has escalated so much over the past couple of months. Contrary to my expectations, the two parties may indeed go their separate ways. 

  16. yeah, although it seems insane to both parties to go their separate ways.  Also, do you still feels there's a 60% chance of the Express Scripts/Medco merger?