Phillies win!! Economy doomed?

Woo-hoooo!!!

The Philadelphia Phillies, the hometown team of your friendly neighborhood blogger, are World Series champions for the first time since 1980! There were loud celebrations in the streets of Philadelphia last night, but few overturned cars and no mass arrests.

Gosh, Adam, what could this mean for the U.S. economic outlook? Funny you should ask!

Two smart-aleck economists at Economy.com put together a sobering analysis called A World Series of Irrational Exuberance, concluding: “The data strongly suggest that a Philadelphia Phillies victory in the current World Series spells bad news for the economic cycle.” Check out this chart from their article:

Oh well. The parade is tomorrow afternoon right outside my office. Stop by if you are in the neighborhood.

Prescriptions and the Economy: A Contrarian View

Last week, the New York Times ran a story on the impact of the economy on prescriptions. (See In Sour Economy, Some Scale Back on Medications.) The article provided many compelling personal stories to illustrate the following macro data trend:

“Through August of this year, the number of all prescriptions dispensed in the United States was lower than in the first eight months of last year, according to a recent analysis of data from IMS Health, a research firm that tracks prescriptions.”

But what if the data are wrong?

I’m not suggesting that the prescription market is booming. However, I have some concerns about the ability of IMS Health to measure a changing retail marketplace with incomplete data, so perhaps the news is not quite as bad as reported.

Here's why. The top six dispensing pharmacies – CVS Caremark (CVS), Walgreens (WAG), Medco Health Solutions (MHS), Rite-Aid (RAD), Wal-Mart (WMT), and Express Scripts (ESRX) – now account for more than half of all retail prescriptions. Yet two of these six do not report sales data to IMS Health.

• As far as I know, Wal-Mart does not sell its prescription records to any third-party data provider.
• At least one of the major mail order pharmacies apparently stopped selling its data to IMS Health in January 2008.

These gaps would not bother me if market share was stable at the top six players because estimation would be a straightforward “fill in the missing number” exercise. But we know that’s not the case, especially when it comes to Wal-Mart.

Wal-Mart does not release any specific data on its pharmacy department, but anecdotal evidence suggests that the company has picked up share in selected regional markets. What do you think is going to happen to Walgreens market share in Peoria, IL, as the Wal-Mart/Caterpillar partnership gets going? Look at a map of Walgreens stores in the Peoria, IL area. Ouch.

The Times gave some lip-service to other explanations for the drop in scripts when briefly noting “…safety concerns over some previously popular drugs and the transition of some prescription medications to over-the-counter sales…” But the main point of the article was to link the economy to the slowdown in script growth.

I suppose it would be unfriendly to mention that most consumer-related metrics of the economy – retail sales, new unemployment claims, etc. – did not start to show signs of recession until this year. Look at the chart in the NYT article again, which shows the monthly year-over-year decline starting in early 2007. Well, this won't be the first time that I've highlighted partisan reporting about the industry by the New York Times. (See Sloppy reporting about Wal-Mart from way back in 2006.)

I’m sure the folks at IMS Health try hard to fill in the gaps, but there’s simply no way for them to do anything but guesstimate when they lack actual data for a significant and fast-changing part of the pharmacy market.

The Walgreens-McKesson Specialty Handoff

Walgreens (WAG) announced the acquisition of McKesson’s (MCK) specialty pharmacy business yesterday in a win-win transaction for two major Drug Channels participants. See Walgreen Co. to Acquire Specialty Pharmacy Business from McKesson Corporation.

The deal makes sense for both parties as long you understand that specialty distributors sell products to physicians, providers and pharmacies, while specialty pharmacies dispense products to individual patients. It also makes a lot more sense for Walgreens than buying Longs Drug Stores (LDG).

GOOD FOR WALGREENS

Walgreens made a good strategic move when it acquired Option Care in July 2007. At the time, I wrote: “Specialty pharmaceuticals are the biggest driver of drug spending right now. There is a lot of money to be made managing the benefits for payers, but that’s only possible by also dispensing these drugs. Thus, Walgreens can continue to grow their small in-house PBM, which is not even ranked in the top 25 based on lives covered. I also think that today's acquisition reduces the likelihood that Walgreens will emulate CVS and acquire a PBM.” (See Walgreens Expands In Specialty from July 2007.)

My conclusion is still valid. Further investment in rolling-up specialty pharmacy fits better with Walgreens than merging with an independent PBM or buying a regional chain with overlapping geography.

The biggest specialty pharmacies are now owned by the big 3 PBMs – CVS Caremark (CVS), Express Scripts (ESRX), and Medco Health Solutions (MHS). Yet the overall specialty pharmacy market is still relatively fragmented, so there is plenty of room for further consolidation. Plus, Walgreens gains further opportunities for disruptive competition with PBMs – a strategic posture that seems to be paying off for Wal-Mart (WMT). (See WMT + CAT: Pharmacy's Future?)

Specialty drugs are also shielded from generics (for now). I expect a pathway for biogenerics to emerge within the next few years, although the strategic logic of the WAG-MCK deal is not affected by this future potential downside.

GOOD FOR MCKESSON

The deal is also a good move for McKesson. Specialty pharmacy is a very small part of the company’s overall specialty business, lacks scale, and is a fundamentally different business than McKesson’s core wholesale distribution operations. The company has wisely jettisoned other non-core businesses, such as the sale of its acute-care med-surg business to Owens and Minor (OMI) in 2006.

McKesson dramatically expanded its specialty distribution business when it acquired OTN/Onmark and combined the businesses under McKesson Specialty. (See my Oct. 2007 post Fresh Consolidation in the Oncology Channel for more on that deal.) McKesson is better off building scale against AmerisourceBergen's Specialty Group (ABC), the current market leader in specialty distribution.

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Hmmm, I sound really upbeat in this post. Hope I’m not getting soft in my old age!

What Happened at Walgreens?

On October 10, Jeffrey Rein unexpectedly “retired” as Chairman, Chief Executive Officer and a director of Walgreens (WAG). The official press announcement gave no reason for Mr. Rein’s sudden departure. According to a Walgreens spokesman: “the decision ‘does not have anything to do with the Longs proposal’ or with any health, family or ethics issues for Mr. Rein.” (Source: Walgreen CEO Rein Leaves Drugstore Firm.)

Which makes people like me wonder…WTF?

Well, I recently stumbled across a very intriguing blog called Investor Relations Musings. It’s written by John Palizza, a fomer Walgreens insider who was the principal investor relations contact for 15 of his 23 years working at the company. Mr. Palizza states that he left Walgreens in 1999 due to a disagreement with Mr. Rein.

In a post last week, Mr. Palizza openly asked and answered the question that many of us are thinking: Why Not Just Tell Us Why You Fired Him?

The whole post is worth reading, but here is Mr. Palizza’s bottom line on the strategic tension inside Walgreens:

“There seems to be two competing long-term strategies at Walgreens over the past nine months – one that was committed to growth at any price, and one that recognized the limits to growth and sought slower growth with higher returns. When the original acquisition talks with Longs did not pan out earlier this year, it would appear that the Board of Directors endorsed a view towards slower growth.

Then, within sixty days of announcing this new strategy, something changed – my guess is that Walgreens’ CEO bought into some new arguments by investment bankers that they could get the Longs deal done – and they decided to publicly pursue Longs. While technically, the acquisition bid is not at odds with the slowing of “organic” growth previously announced, investors were confused.

Finally, when Walgreens’ CEO couldn’t get the deal done, the Board axed him for both zigging when they had publicly said they were going to zag and failing to be a strong enough leader to get the job done.”

I’ve been similarly confused by Walgreens actions over the past few months. Last Thursday’s Drug Channels post Will the economy hurt drug stores? (answer: probably not) was inspired in part by Mr. Rein’s comments on Walgreens’ September 30 earning call. He said:

"We are facing a continuation of the slowest-growing prescription drug market in 47 years, according to IMS Health. We believe the biggest impact has been the very tough economy." Source

Leave a comment below and tell me what you think happened at Walgreens. Or if you prefer, just tell me who will win the World Series.

Will the economy hurt drug stores?

The economic outlook for 2009 looks grim. The Wall Street Journal’s October survey of economic forecasts puts the odds of recession at 89% and forecast negative GDP growth through the first part of 2009. U.S. retail sales dropped sharply in September, leading to another down day on the stock market.

So what, if anything, does this mean for overall sales at drug stores in 2009?

Based on the historical evidence … not much.

I looked at year-over-year changes in quarterly retail sales at Pharmacies and Drug Stores (NAICS 44611) as collected by the Bureau of the Census. These government-collected data provide the most complete picture of revenues at all drug stores, not just the big public companies. Note that these data exclude non-pharmacy dependent retail formats, such as supermarkets or mass merchants, and also combine prescription and front-end sales.

I compared these data to U.S. Gross Domestic Product (GDP) and Total U.S. Retail Sales data. The chart below tells the story – there was no clear relationship between changes in GDP and drug store sales during the past 8 years. (Click to enlarge the chart.) There was also no clear relationship in the 1990s (not shown).

Changes in sales at pharmacies and drug stores were not strongly correlated with changes in either GDP (-40%) or total retail sales (-41%; not shown). In fact, the correlation was actually negative, i.e., drug store sales tend to go up when GDP goes down. In case you’re wondering, changes in total retail sales had a +90% correlation with changes in GDP over the same time period.

The chart above also illuminates the sharp slowdown in year-over-year growth at drug stores that began in early 2007, which was well before the recession started. I think this trend reflects more fundamental industry forces at work, such as a lack of new blockbusters and rising generic utilization rates (which reduces revenue but boosts profits). The nature of health care products also implies limited sensitivity to a downturn.

A further piece of evidence comes from same-store sales at major retailers. (See Consolidated Summary of Sept Retail Sales Results.) Twenty-eight of 36 major retailers had negative same-store sales growth in September. Who was up?

• Discounters: Wal-Mart (WMT), Costco (COST), BJ's Wholesale (BJ)
• Drug Stores: Walgreens (WAG), Rite-Aid (RAD), Fred's (FRED)
  

Do these facts “prove” that drug store revenues will hold up in 2009? No, of course not. The future could look quite different than the past.

But as Mark Twain said: “History does not repeat itself. But it rhymes.”

Great Series from the Columbus Dispatch

Over the weekend, the Columbus Dispatch published a six-part expose/overview about the diversion and sale of controlled substances. Mike Pramik, the reporter who wrote all six parts, has pulled together a must-read series, especially since the Dispatch is also Cardinal Health’s (CAH) hometown paper.

Here are links to the six parts along with my commentary on each article.

Online Overdose – The main article provides a succinct summary of the biggest problem with the pharmaceutical supply chain today. Guess what? It’s really easy to get controlled substances via rogue Internet pharmacies sites, which “flourished in a virtually unchecked pharmaceutical supply chain that allowed anyone to answer a few questions and easily receive addictive medications, the same controlled substances that are in high demand on the street.” Lots of good facts and quotes, including one from yours truly. For more background, see my post The DEA's Anti-Diversion Strategy.

Cardinal pays up for drug slip-ups – A behind-the-scenes look at the problems that led to the license suspensions at Cardinal Health (CAH). Mike even quotes Richard Molitor, whom I interviewed back in February 2008. There are some eyebrow-raising statements in this article about what happened between the DEA and Cardinal, including some very negative statements from Cardinal’s former director of compliance. Hard to tell what is true and what is spin. Regardless, Mike did some nice reporting to pull together this story.

Small-town pharmacist caught up in scheme – The strange tale of how independent pharmacist Steve Holtel of Stoltz Drugs got mixed up with a national scheme to fill false prescriptions faxed from other states. All pharmacists should read this cautionary tale, although Mr. Holtel is a complex character with a troubled legal past.

Ex-employee, Cardinal both profited in buying discounted medicine – Summary of previous allegations about secondary market trading by Cardinal employees. You can read more in Dangerous Doses or Cardinal’s agreement with then-New York attorney general Eliot Spitzer.

Pending law will regulate online prescription-drug sales – Summary of the Ryan Haight Online Pharmacy Consumer Protection Act, which will be signed by President Bush any day.

Demand for addictive drugs testing security – Drug addicts are quite persistent.

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Today’s photo has nothing whatsoever to do with this post. It’s just a friendly reminder of another great series from this blogger's hometown (despite last night's game)!

Cardinal: The Once and Future Wholesaler

Last week, Cardinal Health (CAH) formally announced plans to spin off its Clinical and Medical Products business. The post-spin business will be a return to Cardinal’s wholesale distribution roots, although getting back is only the beginning. Here are a few high-level thoughts on the pharmaceutical distribution business.

First, congratulations to management for (finally) resolving the DEA issues that have been plaguing the company since last November. (See Cardinal Health Resolves Controlled Substance License Suspensions.) I’ve written critically on Drug Channels about Cardinal’s handling of the situation and the impact on its market position with independent pharmacies and small chains. Cardinal even publicly apologized for its actions in June.

I’ve been a fan of George Barrett’s straight talk about Cardinal’s problems, especially when he publicly confirmed what I was saying on Drug Channels about market share losses among independent pharmacies. The company’s FY2008 10-K quantifies the damage:

• Overall revenue growth for the pharmaceutical distribution segment was 3.5%, which is below the company’s estimated rate of drug price inflation of 7.7% during the same time period. In other words, Cardinal’s revenues declined in real (inflation –adjusted) dollars.
• Revenue declined by $1.9 billion due to a “loss of customers.” The net effect was smaller because of price inflation, general volume growth, and the gain of new customers.
• Cardinal’s revenues from its smaller (non-bulk) customers declined by 1.6% ($680 million), while revenues from its bulk customers – such as CVS Caremark (CVS) and Walgreens (WAG) – grew by 10% ($3.4 billion).

Speaking of bulk customers, the CVS Caremark brand supply contract with Cardinal expires in mid-2009 – right around the time of the spin-off. In my opinion, this coincidence implies that management expects to continue servicing CVS Caremark’s retail business, which I have always viewed as the most likely outcome. See Wholesaler Impact of a Longs Drug Deal for background on the CVS Caremark/Cardinal/McKesson relationship.

Cardinal still faces many company-specific issues, as I noted inelegantly in an August Wall Street Journal article: “There are certainly some things that are out of Cardinal's control, such as the consolidation of retail customers; however, there are some specific issues that Cardinal has had to deal with...that are very Cardinal-specific.” Sounds like my training at the Department of Redundancy Department paid off!

BTW, anyone else catch the following comment by Mr. Barrett from last week’s conference call: “[W]e will be exploring opportunities to expand both into new adjacent spaces and perhaps new geographies. Having said this, our immediate focus is here at home and on our core businesses.” Cardinal Goes to China, perhaps?

Why California (Still) Matters - my podcast!

Paul Thomas from Pharmaceutical Manufacturing interviewed me in early September about pedigree and serialization. You can now listen to a 13 minute excerpt in the optimistically named podcast Why California (Still) Matters.

It provides a quick overview of key issues regarding supply chain security, compliance costs, state versus federal legislation, and data ownership issues.

Be forewarned -- you will hear “serious Adam,” i.e., no goofy Terminator or Spinal Tap jokes. As compensation, read about how California doesn't want anything else in their state going to 11 in this hilarious letter to the DMV -- pay attention to legal Exhibit 1. (Thanks to Will Murchison at NACDS for pointing me to this important story!)

My podcast is included in PM’s latest e-newsletter, which has many interesting stories including a recent webcast with Virginia Herold from the California Board of Pharmacy. Good stuff.

Still can’t get enough? Then check out the latest Health Wonk Review, the latest collection of punditry from around the web.

CA E-Pedigree: Hasta La Vista, 2011

Judgment day was September 30, 2008.

As expected, Governor Schwarzenegger finally signed SB1307, the California bill extending the implementation deadline for the state's serialized e-pedigree law. See CA E-Pedigree: Going to ... 2015 for background and implications.

On a related note, check out Pharmaceutical Commerce's Serialization Survey, which shows that most manufacturers plan to continue with serialization initiatives (based on responses from 82 pharma/bio manufacturers). At the time of the survey, about one-quarter are currently serializing product or conducting a production pilot, while 35 manufacturers (43%) were planning to get started within 12 months.

As I noted in September, “mass serialization” will become increasingly important for supply chain security efforts at multinational drug makers, especially given the new serialization requirements in countries such as Belgium, Italy, and Turkey.

In contrast, I expect to be writing much less about pedigree in Drug Channels over the next 12 months.

Cardinal Goes to China

Let’s take a break from bailout talk and look at China, which is not just a source for counterfeit drugs. It’s also one of the fastest growing markets for (legitimate) pharmaceuticals and is projected to be the fifth largest market within a few years.

Way back in a January 2007 post, I pointed out the growth opportunity for U.S. drug wholesalers in China. So I was especially intrigued by Pharmaceutical distribution at the heart of Cardinal Health’s China Strategy, a just-published interview with Jason Chen, head of Cardinal Health’s (CAH) Asian operations.

According to the article, Cardinal is rapidly growing its Chinese drug distribution business, while expanding manufacturing in India (but not China). This strategy is especially interesting given Cardinal’s anticipated separation of its supply chain division from clinical & medical products.

Just consider what’s been going on in China, where the number of drug distributors in China has been dropping rapidly since the Chinese government began opening up the market in 2003. A few notable foreign investors:

• Swiss-based Zuellig Pharma has long been a major player in Asia and established a Chinese presence before distribution industry was open to direct foreign investment.
• Global wholesaler Alliance Boots entered in January 2007 by buying a 50 percent stake in Guangzhou Pharmaceuticals Corp., the third-largest pharmaceutical wholesaler in China.
• US-based BMP Sunstone (BJGP) has been actively acquiring Chinese drug wholesalers. (BMP is also linked to Alliance Boots via the Guangzhou investment.)

The era of global wholesalers is coming, with or without a U.S. importation law. Perhaps it's time to start considering how it will alter manufacturer-wholesaler relationships.

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And to those readers for whom it is relevant: L'Shanah Tovah!

Don't Bet Against Medco or CVS, either

As a follow-up to Tuesday’s post about Express Scripts (ESRX), both Medco Health Solutions (MHS) and CVS Caremark (CVS) have now been added to the "no short sale" list. The Wall Street Journal headline sarcastically asks: New To The Financial Sector: Medco, CVS And IBM? So, do you think it's too late for me to start a failing investment bank and get a bailout?

The comments on my original post speculated that a small (less than 10%) ownership stake by New York Life Insurance put ESRX on the list. But even Express Scripts was not initially sure how it ended up on the list. See Not All Cos Guarded By Short-Sales Rule Strictly Financial from Tuesday, which says:

If you're wondering why drug-plan administrator Express Scripts Inc. (ESRX) was added to the (do not) short list of financial stocks, so is Express Scripts…"We have no financial services business. The list came out, and our name was on the list," he said.

Express Scripts has since stated that it got on the list because of a small insurance subsidiary associated with administration of Medicare Part D. The subsidiary is "very tiny, highly specialized," involving a few thousand of the company's tens of millions of clients. (Source)

Not be outdone, Medco clamored to get on the list, supposedly because it too has a small insurance plan. Per the WSJ article:

“They were asking why Express appeared on the list and we did not. To us, it's an issue of fairness as well as an issue of relief from excessive” market turmoil, said Medco Health spokeswoman Ann Smith.

Apparently, one-seventh of all stocks are now on the list. Glad to see that the SEC is being so stringent. As my daughter would say:

Whatever.

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In related economic news, I prefer The Onion’s suggestion for an economic stimulus over the new bailout bill. See Recession-Plagued Nation Demands New Bubble To Invest In, which notes:.

According to investment experts, now that the option of making millions of dollars in a short time with imaginary profits from bad real-estate deals has disappeared, the need for another spontaneous make-believe source of wealth has never been more urgent.

The manner of bubble isn't important—just as long as it creates a hugely overvalued market based on nothing more than whimsical fantasy and saddled with the potential for a long-term accrual of debts that will never be paid back, thereby unleashing a ripple effect that will take nearly a decade to correct.

Oh yeah!!

WMT + CAT: Pharmacy's Future?

Yesterday, Wal-Mart Stores (WMT) announced an innovative new program with Caterpillar (CAT) that provides $0 co-pays on 2,500 generic drugs for 70,000 beneficiaries (employees, retirees, spouses, dependents). See Caterpillar in prescription drug trial with Wal-Mart.

Well, I can’t resist pointing out that my January post Wal-Mart's PBM Game Plan predicted Wal-Mart’s strategy. Give the post another read because the economic logic is still generally accurate, plus there is a good discussion in the comments below the post.