McKesson Wins the VA…at Cost minus 8.65%!

Last night, the Department of Veterans Affairs announced that McKesson had retained the much-delayed pharmaceutical prime vendor (PPV) contract. Here’s the press release: McKesson Selected By Department Of Veterans Affairs As Prime Pharmaceutical Supplier To VA Healthcare System.

Based on the pricing (details below), McKesson REALLY wanted to win the contract, which will now contribute about 40% less in earnings per share.

While the VA contract is unique, McKesson’s biggest customers—CVS Caremark (mail), Rite Aid, Walmart, and Omnicare—will surely be curious to know more about this wacky math. Manufacturers, however, should feel a sudden urge to hold onto their wallets.

The contract is potentially 8 years long: an initial two year period and three option periods of two years. George Hill at Citigroup estimates the total 8-year contract value to be $31.6 billion, or about $4 billion per year.

Click here to view the official award on the VA site. The reported pricing discounts are quite astounding:

• Fast Pay Accounts (including CMOP): -8.65%
• Net 15 Accounts: -8.15%
• Medical/Surgical Items: -8.65%
• WAC Based Priced Generics (WBPG) (including CMOP): -8.65%

Larry Marsh at Barclays Capitals estimates that the new contract will contribute $0.19 in earnings per share (EPS), vs. $0.33 for the current contract.

Curious how the math works for an 8.65% discount? See Big Trouble in the VA Contract: Who will win?, where I explain the two key factors behind so-called "cost minus" pricing:

1. Buy-side margin allows the wholesaler to offer discounts from "cost" while still earning a positive gross margin.
2. "Fast Pay" terms can provide a wholesaler with negative working capital.

There is also no accounts receivable or bad debt risk...as long as the U.S. doesn't go bankrupt in the next 8 years. (Unlikely, I hope.) For more on the oft-misunderstood drivers of wholesaler profits, read Chapter 4 of the 2011-12 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors.

In January, I gave McKesson a 40% chance of remaining the sole-source vendor. In February, I upped it to 55% after the House Committee on Veterans’ Affairs hearing. Looks like I'm ready for another trip to Vegas!

P.S. My analysis of the mail pharmacy slowdown will appear tomorrow.