Express Scripts - Medco Deal Creates A Headache For Shareholders

| About: Express Scripts, (ESRX)

Shares of Express Scripts Holding Company (ESRX) fell 12.3% in Tuesday's trading session. The company which manages billions of prescriptions for millions of consumers on behalf of employers, health plans and unions, reported its third quarter results on Monday after the close.

Third Quarter Results

Express Scripts reported third quarter revenues of $27.0 billion, up 133.3% on the year. The spectacular growth is driven by the acquisition of Medco Health Solutions.

The company reported gross profits of $2.13 billion, up 155% on the year. Gross margins increased by 60 basis points to 8.1%.

Express reported a net income of $391.4 million, or $0.47 per diluted share. Net income was up 20.5% on the year, while earnings per share fell 28.8% on the year. The number of shares outstanding increased significantly after acquiring Medco.

Adjusted earnings came in at $1.02 per diluted share, up from $0.79 per share last year. Earnings beat analysts consensus of $0.99 per share. Express took a $495.9 million amortization charge related to the Medco acquisition, and $179.1 million in transaction and integration costs.

The company processed 398.9 million in total adjusted claims during the quarter.

CEO and Chairman George Paz commented on the results, "Our solid third quarter results demonstrate our continued success as a combined organization. Integration continues on track and together we are building on our legacy of advancing healthcare through innovation and an unwavering alignment with our clients."


For the full year of 2012, Express Scripts expects to report adjusted earnings per share of $3.65-$3.75. The outlook assumes fourth quarter adjusted earnings per share of $1.02 per share at the midpoint of the range. On average, analysts expected Express to guide for adjusted earnings of $1.05 per share.

Express Scripts will provide a 2013 outlook at the presentation of the fourth quarter results. Based on current business circumstances, the company is not too optimistic given the weak business climate and the unemployment outlook. On average, analysts expected Express Scripts to earn an adjusted $4.49 per share for 2013. Given the cautious comments of Express at the third quarter presentation, this seems a bit too ambitious.

CEO Paz commented on the outlook, "Despite near-term headwinds and a challenging macroeconomic environment, we remain confident we are will-positioned for continued growth. We have historically managed expenses rigorously while investing toward the future, focusing on innovation, service and optimal clinical outcomes, and will continue to do so, even when faced with challenges on other fronts."


Express Scripts ended its third quarter with $1.3 billion in cash, equivalents and investments. The company operates with $17.1 billion in short and long term debt, for a sizable $15.8 billion net debt position.

For the first nine months of 2012, Express Scripts generated revenues of $66.8 billion. The company net earned $808.8 million, or $1.13 per diluted share. The company is on track to generate annual revenues of $89 billion, on which it could earn almost $1.1 billion, or $1.50 per share.

After Tuesday's decline, the market values the firm at roughly $51 billion. As such, the market values the firm at 0.6 times annual revenues and 37 times annual net earnings, or 15 times adjusted earnings.

Express Scripts currently does not pay a dividend.

Investment Thesis

Year to date, shares of Express Scripts have risen some 23%. Shares rose from $45 in January and steadily rose to $66 earlier this month. After Tuesday's decline, shares are exchanging hands at $55 per share.

Over the past five years, shareholders have seen shares increase by some 70%. Shares rose from lows of $20 in 2009 to $55 at the moment.

Express Scripts has been transformed by the $29 billion acquisition of Medco Health Solutions (MHS) in an attempt to save roughly $1 billion in costs per annum. The combination will handle roughly one in three prescriptions in the US. The pharmacy-benefit manager, has been under close scrutiny from anti-trust agencies. Regulators are focused to promote competition in order to improve higher quality healthcare at lower costs. After a review period of eight months, Express got regulatory clearance for the acquisition.

Tuesday's sell-off is entirely attributable to the cautious comments for 2013. The company warns that analysts estimates are too aggressive for the coming years. This warning caused new doubts among investors who question the success of the integration of the Medco deal. The $29 billion deal seems a little rich in hindsight, given that the $1 billion synergy target seems unattainable in the short term.

Express Scripts furthermore warns about the loss of claims from UnitedHealth Group (UNH). Another worry is the rising out-of-pocket expenses to be paid by patients in a poor economy amidst high unemployment.

The sell-off in Express Script's shares is no overreaction. The fact that the company warns about its 2013 outlook already is a big red flag, especially after the $29 billion Medco deal last year. I would stay away given the integration struggles, the fairly high debt position, none appealing valuation and lack of dividends.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Health Care Plans, Earnings
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