Express Scripts And Competition In Pharma Benefits

| About: Express Scripts, (ESRX)

Pharmacy Benefit Management (PBM) operation's clients are typically employers who are self-insured, governmental entities (i.e., state employees, military), unions, third party administrators and managed care companies.

The PBM business is dominated by Express Scripts Holding (NASDAQ:ESRX) and CVS Caremark (NYSE:CVS).

Express Scripts is the largest pharmacy-benefit manager in the U.S., since it acquired Medco Health Solutions last year for $29.1 billion, and now has 100 million members.

Express Scripts manages more than a billion prescriptions each year for tens of millions of patients.

The company is essentially a middleman that negotiates discounts in prescription drug prices from manufacturers of drugs for clients such as health maintenance organizations (HMOs), insurance companies, employers, workers compensation plans, government health programs, and third-party administrators.


For some drugmakers with few products, PBMs can play a big role when they decide to cover, or decline the cost of certain drugs for members.

For example Express Scripts' recent decision to pay for Vivus' (NASDAQ:VVUS) weight-loss drug Qsymia, which has suffered from lagging uptake, was seen as a boost to that drug. The decision was followed soon by a favorable bulletin from Aetna (NYSE:AET) and the addition by Wal-mart (NYSE:WMT) to its home delivery network.

On the flip side, in the past year the CVS Caremark PBM expanded the list of drugs it refuses to cover to more than four dozen. The list includes drugs like Allergan's (NYSE:AGN) glaucoma drug Lumigan, Pfizer's (NYSE:PFE) growth hormone Genotropin and diabetes treatment Onglyza from Bristol-Myers Squibb (NYSE:BMY) and AstraZeneca (NYSE:AZN). Some of the drugs were "blacklisted" because they come with drugmaker coupon cards, which encourage patients to stick with higher-priced branded drugs as opposed to lower priced generics.

In 2012 Express Scripts merged with Medco Health Solutions, creating the largest mail and specialty pharmacy. Before the merger Medco was the third-largest U.S. pharmacy by revenue.

However, Express Scripts' market share now is less than the combination of the two companies would be, because Medco has lost some big contracts like UnitedHealth's commercial business to OptumRx.

The FTC raised no antitrust objections to the merger, because it thought that smaller and health plan owned PBMs are stronger competitors for employer business than the Big Three. They have polled customers, among them many Fortune 100 companies, which viewed the transaction as competitively harmless or even stimulating for competition.

Walgreen vs Express Scripts

Walgreen's prescription revenue suffered due to its exit from the Express Scripts retail pharmacy network in January 2012.

In mid-September 2012, Walgreen re-entered the network, although it is still excluded from the Tricare network, which covers military members and their families.

Walgreen's loss of sales was offset by new store openings, a strong flu season, and its re-entry into the Express Scripts networks for the last 15 weeks of the year. Through December, Walgreen has recaptured about 40% of the prescriptions from the Express Scripts dispute. At the end of 2012, Walgreen operated 8,061 drugstores, a net increase of 243 during the year.

But by September 2012, year-over-year Walgreen's sales declined by 10 percent to 15 percent, while sales increased at rival chains. CVS' retail pharmacies gained 6.5 million to 7 million new prescriptions from former Walgreen's customers. CVS expects to retain 60 percent of these customers.

Enter Costco

There are new players in the pharmacy management business, like Costco.

Costco is a membership-warehouse club with 447 U.S. locations, most of which have a pharmacy. Its estimated prescription revenue for 2012 will be about $1.6 billion.

The program offers prescription medicines through Costco's in-warehouse pharmacies and a network of 64,000 independent pharmacies that have agreed to pre-negotiated prices.

Costco will provide all discounts, rebates and other revenue back to the employers. Thus, there is no spread between the amount charged by Costco to a plan sponsor and the amount paid by Costco to the retail network pharmacy that dispenses the drug to a consumer. Costco's aim is to gain additional customers for its stores.

Investor's summary

Express Scripts' estimated revenue for 2012 is $116.2 billion.

During the third quarter, the company repaid $1.1 billion of debt, which included Medco's $600 million accounts receivable financing facility, which was terminated, in line with the company's plan to quickly delever.

Earnings per share for the year is projected in the range of $3.65 to $3.75, representing growth of 25% over 2011.

In the third quarter the company has added 215 new accounts, exceeding sales targets.

Express Scripts generates a huge free cash flow (in the last nine months nearly $2 billion), but the company is neither buying back stock nor paying a dividend.

Express Scripts told the JPMorgan Global Healthcare Conference in January about some potential catalysts ahead.

One is the cost of drugs.

The price curve of drugs is expected to turn higher in 2013 and 2014 after flattening out in recent years. More than 600 new drugs coming to the market is one of the primary reasons the price curve will turn higher.

Higher drug costs will likely have drug buyers looking for alternatives and Express Scripts should be a major beneficiary that is serving a third of the U.S. population.

ESRX also stands to profit from Obamacare.

One of the biggest costs in pharmacy is related waste. More than $400 billion a year is flushed down the toilet - sometimes literally. The main cause is that people are not taking medicine as prescribed, also generics are not always used when available.

For example, studies show that home delivery improves adherence by at least 20 percent. That's a lot of savings. ESRX is data mining its client database to identify non-adherers and help them change their habits.

On the negative side, the current weak business climate and the unemployment outlook will likely result in significant member attrition in 2013, continued low utilization rates and increased client demands and expectations.

The ESRX share price ranged in the past 52 week from $45.93 to $66.06.

Express Scripts gapped down in early November, on earnings that disappointed Wall Street. ESRX shares fell from a close of $62.88 on November 5, 2012, to $55.15 the next day and lingered around that price since.

Short-term traders are watching if Express Scripts Holding Company can break out above $56.17 to cover the gap.

Longer-term investors keep in mind that Express should benefit from an aging population and the desire to contain the cost of drug prices, which are expected to trend higher in the year ahead.

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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