Tuesday, June 07, 2016

How CVS Health Got McKesson Under Its Thumb

Last month, McKesson released the annual report for its 2016 fiscal year, which ended on March 31, 2016.

The report provided one big surprise: McKesson’s sales to CVS Health, its largest customer, grew to $38.7 billion—up by an astonishing $12 billion (+44%) from the previous year’s figure. We estimate that CVS Health accounted for about one-quarter of McKesson’s total North American drug distribution revenues. Wow.

Below, I review the history of the McKesson-CVS relationship and explain the factors that have driven this recent hockey stick growth.

This much is clear: The change has come.


Longtime readers know how much I enjoy Securities and Exchange Commission (SEC) corporate filings. Regulatory and legal requirements force companies to disclose important details about their businesses. These filings offer a fascinating—albeit dense and opaque—source of competitive intelligence that surprisingly few people bother to read closely.

I rummaged around in McKesson’s 10-K filings to create the chart below. It shows McKesson’s annual revenues from CVS Health. In McKesson’s 2016 fiscal year, its sales to CVS Health were $38.7 billion—up substantially from previous years’ sales.

[Click to Enlarge]

In McKesson's 2014 fiscal year, its sales to CVS Health were a mere $22.0 billion. Ain't it the truth, babe.


The chart’s big increase can be traced directly to both the organic and the acquisitive growth at CVS Health.

McKesson primarily supplies CVS Health’s Caremark mail and specialty pharmacies, which have been enjoying impressive organic growth due to the specialty boom:
  • As I discuss in Section 7.4. of our 2016 Economic Report on Retail, Mail, and Specialty Pharmacies, plan sponsors often require patients to use the specialty pharmacy that its PBM owns and operates. Last December, Caremark reported that an impressive 35 million of its beneficiaries have only CVS Health outlets as their specialty provider.
  • CVS Health’s Specialty Connect program, which launched in 2014, lets patients who are taking specialty drugs choose between in-store pickup at a retail location or mail delivery from a Caremark specialty pharmacy. This program shifted revenues away from CVS Health’s retail pharmacies, which are supplied by Cardinal Health. (Yes, CVS can still look at someone else.)
McKesson’s revenues from CVS Health were further boosted by CVS Health’s recent big acquisitions:
  • On August 18, 2015, CVS Health completed its acquisition of Omnicare. More than 60% of McKesson’s 2016 fiscal year sales to Omnicare were therefore reclassified as sales to CVS Health. Note that McKesson lost some generic sales that shifted to CVS Health’s Red Oak joint venture with Cardinal Health.
Note that these transactions closed in the middle of McKesson’s 2016 fiscal year. Next year, the full effect of these deals will show up in McKesson’s financials. I suppose McKesson will then be the sweetest, hmmm, pet in the world.


McKesson is not immune to the challenges that I describe in AmerisourceBergen Charts the Profit Headwinds Facing Drug Wholesalers. Like its peers, we estimate that McKesson earns much lower profit margins from its biggest customers.

McKesson has made multiple investments to counteract this downward pressure, including its recent Biologics and Walmart transactions. (See Inside McKesson’s Acquisition of Biologics Specialty Pharmacy and Why Walmart Is Finally Joining McKesson for Generic Purchasing.) McKesson has also developed a large pharmacy franchise, built a strong position in the distribution of provider-administered specialty drugs, and is now weighing the sale of its Technology Solutions division.

Bottom line: McKesson can;t take it easy, baby.


In the video below, noted business guru Michael Philip Jagger explains how large pharmacies can best manage their pharmaceutical wholesale supply relationships. Click here if you can’t see the video.

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