Thursday, June 09, 2016

Valeant Reveals the Bad News about Its Money-Losing Walgreens Relationship

On Tuesday, Valeant Pharmaceuticals, the troubled hedge fund masquerading as a drug maker, finally released its first quarter earnings. It also lowered its 2016 guidance. Valeant’s stock dropped 15% on Tuesday, and is down 90% over the past year.

On its earnings call, Valeant disclosed new details about its relationship with Walgreens Boots Alliance (WBA). The news was not good. Due to what Valeant euphemistically called “speed bumps,” it ended up losing money on many prescriptions that Walgreens dispensed.

Thanks to the shrewd negotiations by the WBA team, Walgreens had no financial risk on these prescriptions. I conservatively estimate that in 2016, Walgreens may earn $50 million or more in dispensing fees from Valeant. Our global channel overlord wins again.

Read on for my best guess as to what’s happening with the Valeant-Walgreens relationship.


In mid-2015, a controversy arose after revelations about Valeant Pharmaceutical’s relationship with mail pharmacy Philidor Rx and other related pharmacies. Many people, including executives from Valeant, referred to Philidor as a “specialty pharmacy.” However, Philidor Rx was a manufacturer-controlled mail pharmacy that dispensed Valeant’s comparatively undifferentiated traditional drug products, not highly differentiated specialty drugs. See Valeant, Philidor RX, and the Uninformed Attack on Specialty Pharmacy.

Philidor Rx provided extensive copay card administration and prior authorization services for Valeant products. The three largest PBMs—Express Scripts, the Caremark PBM business of CVS Health, and the OptumRx PBM business of UnitedHealth Group—all removed the Valeant-affiliated Philidor pharmacy from their networks. See After the Valeant-Philidor Blowup, PBMs Clamp Down on Network Pharmacies. Valeant subsequently shut down Philidor.

Last December, Walgreens Boots Alliance (WBA) and Valeant announced a preferred pharmacy network for Valeant’s branded products. See Walgreens and Valeant Devise a New Twist on Preferred Pharmacy Networks. Walgreens clearly stated that it would operate very differently from how Philidor did. See the WBA management comments that I highlighted in Walgreens Boots Alliance Spins the Valeant Deal, Preps for Rite Aid, and Hints at a PBM Acquisition.

During Valeant’s disastrous March earnings call, Pearson clarified that Walgreens earned an “activity based fee” based on how much adjudication work Walgreens does with each script. Pearson stated:
“What I mean by activity based is that they get paid different amounts based on different scripts. If it’s cash paid script, it's one fee, if they adjudicate insurance, we pay a little bit more. If they do a prior authorization, we pay a little bit more. If they do workaround refills, we pay a little bit more. So, it's an activity based fee.” (source)
Pearson also revealed that there were more cash pay prescriptions at Walgreens compared with those dispensed by Philidor. I interpreted his statement to mean that a Walgreens pharmacist was either unable or unwilling to devote as much time to getting a script through the payer’s prior authorization (PA) hurdles.

In other words, Valeant apparently agreed to pay a fee to Walgreens even if there was no third-party coverage. So what would stop a Walgreens pharmacist from dispensing anything with a tricky PA as a cash-paid script and just collecting the fee?

Put another way: Stefano Pessina, global channels overlord and Executive Vice Chairman and chief executive officer of WBA, negotiated a great deal for Walgreens at Valeant’s expense. Shocking, I know.


As always, I encourage you to read in the original company sources for yourself. Here are direct links to materials for Valeant’s 2016 first quarter results:
On Tuesday’s call, new Valeant CEO Joseph Papa was forced to come clean about the abysmal economics of the Walgreens arrangement. He referred to these issues as “speed bumps in Walgreens program start-up.” Um, OK.

Here is Papa’s key point about its Walgreen relationship:
“A significant portion of our Walgreens prescriptions have profitability significantly below our internal projections and meaningfully below non-Walgreens prescriptions. In some instances, these prescriptions actually have a negative average selling price." (emphasis added)
For those who don’t know, “negative average selling price” (ASP) is a euphemism for “whoops, we sold the products at a loss.” Papa added: “Every time a prescription goes out the door, we’re taping dollar bills to that prescription as it goes out the door. That’s something that we have to get fixed.”

He’s right. That business model works only in Silicon Valley.


Valeant tried to put a positive spin on the Walgreens relationship by touting “early indications of recovery.” By the end of May, Walgreens had been fulfilling about 70,000 scripts for Valeant’s dermatology products. (See the chart below.)

[Click to Enlarge]

If I’m reading the above chart correctly, only about one-third of these prescriptions received commercial coverage. These uncovered scripts explain Valeant’s disclosure that it lost money on products dispensed at Walgreens.

Consider the following three scenarios:
  • Cash pay—Patient pays the full cost of the prescription. As long as the patient’s payment exceeds Valeant’s costs, then Valeant earns a profit on this prescription. Walgreens earns its dispensing fee.
  • Third-party coverage—Patient pays a copayment or coinsurance. Third-party payer reimburses the balance of the prescription cost. Again, Valeant should make money on this script. Walgreens earns a dispensing fee that’s higher than the cash-pay scenario.
  • Third-party coverage with prior authorization—Here’s where things get dicey. Valeant allows Walgreens to dispense the product before the prior authorization is cleared and third-party payer reimbursement is confirmed. In other words, Valeant goes “at risk” for reimbursement. I presume that in most circumstances, the patient walks out of the pharmacy after paying a copayment that was below the product’s cost.

    If the PA is subsequently rejected, then the remaining balance of the prescription cost is not reimbursed. Valeant has to swallow a loss (negative ASP) on the script—and also pay a fee to Walgreens. However, Walgreens has no risk, because Valeant sells its products on consignment to Walgreens. Well done, Mr. Pessina!
I estimate that in 2016, Walgreens could end up dispensing more than 4 million scripts for Valeant. If we assume average dispensing fees of $12 to $15, then Walgreens will earn fees of $50 million—and possibly more. Almost all of these incremental profits will drop to WBA’s bottom line. Sweet.

Valeant intends to fix what it terms “unintended ASP consequences.” (Renegotiate the Walgreens arrangement, perhaps?) Valeant also announced that it had contracted with a “qualified” third party-vendor that will take over prior authorization support for products dispensed by Walgreens. I presume this means that it will hire a Philidor-like entity to provide hub services that can climb the PA paperwork mountain when Walgreens won’t do it.

I’m reminded of Warren Buffett’s two rules for business success:
  • Rule 1: Never lose money.
  • Rule 2: Never forget rule No.1.
At this point, it’s not clear that PBMs and payers will give Valeant time to learn these lessons.

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