On April 13th 2009, Express Scripts (NASDAQ:ESRX) announced that it bought a 10 year contract to manage, and receive all proceeds from, the book of business of Wellpoint’s pharmacy benefit manager, NextRx. Express Scripts paid $4.7 billion for that contract, saying that “deal will generate more than $1 billion of incremental earnings, before interest, taxes, depreciation and amortization within 12-18 months after closing”.
During its recent 3Q2010 conference call, Express Scripts provided FY11 guidance and stated that “we are confident we will complete the integration and achieve our synergy targets in the year. And as a result, our 2011 guidance includes $1 billion of incremental EBITDA.”
Based a comparison of Express Scripts’ FY11 EBITDA guidance and our estimate of its organic growth since 2009, we believe that Express Scripts has missed on its estimate of the contribution of NextRx.
Express Scripts reported EBITDA of $1,697 million in 2009, which included only one month of contribution from its acquisition. Assuming a conservative organic EBITDA growth of 18% compounded, we estimate organic EBITDA at the end of 2011 to be $2,363 million.
In its 3Q2010 conference call, Express Scripts guided FY11 performance to between $3.70-$3.90 EBITDA per adjusted script and between 750 and 780 million adjusted scripts. This implies a total FY11 EBITDA guidance of between $2,775 million and $3,042 million.
Subtracting total EBITDA guidance from our estimated organic EBITDA yields an estimate of incremental contribution from the NextRx acquisition of between $412 million and $679 million, far below the Express Scripts assertion of $1 billion in incremental EBITDA.
Indeed, the assertion that one-third of total FY11 EBITDA will come from the NextRx acquisition can only be true if organic EBITDA since 2009 had grown at a paltry 5% rate.
It is not that the acquisition, or Express Scripts’ organic business, is underperforming. It is that the $1 billion guidance never was consistent with Express Scripts’ own valuation of the business when it bought it in 2009.
Consider the $4.7 billion Express Scripts paid for the 10 year contract as a valuation based on discounted cash flow. A decent return would be had with a yearly cash flow in the neighborhood of $600 million. On the other hand, the contract would have been valued at more than $7 billion has Express Scripts, and other bidders, really believed that the business was capable of generating $1 billion of yearly EBITDA over 10 years.
It’s as if those who arrived at the valuation were operating under a completely different set of assumptions about the nature of the NextRx business than those who came up with the $1 billion guidance.
Disclosure: No Position in ESRX