CVS Might Have Tougher Times Ahead As Competition In The PBM Market Heats Up
The United States has the most expensive healthcare system in the world. Government spending on heath care forms about 18% of the country’s GDP currently and the share is only expected to go up with time. If the historical growth rate of health care costs continues, projections place the share by 2040 at a whopping 34% (over a third of the GDP!) [1]. As prices of drugs (even generics) scale new peaks, consumers are increasingly feeling the pressure on their pockets. However, this is what pharmacy benefit managers (PBMs) make a living out of.
In 2014, the size of the PBM market stood at $263 billion, more than half of which CVS Health (NYSE: CVS) and Express Scripts Holding Co. (NASDAQ: ESRX) together control. CVS Health doubled its PBM revenues in the last five years and it comprised almost two-thirds (63%) of the company’s total revenue during the last fiscal year (ended January 2015). However, the market dynamics have changed a lot in the last few years, as new players entered the market and existing players merged into larger companies (resulting in considerable scale advantages). Below, we take a look at how the PBM market has changed over the years and evaluate its impact on CVS’ position.
View our detailed analysis for Rite Aid
Some Background on Pharmacy Benefit Management
Pharmacy benefit managers, or PBMs, act as intermediaries between the payor and the consumer in the health-care system. They process prescriptions for the groups that pay for drugs, usually insurance companies or corporations, and use their scale to negotiate with drug manufacturers and pharmacies. They generally make money through service fees from large customer contracts for processing prescriptions, operating mail-order pharmacies, and negotiating with pharmacies and drug makers. While some of the savings generated from negotiations are passed on to customers, a good portion of it contributes to the PBM’s earnings. [2]
A Brief History Of The PBM Industry – Key Mergers & Acquisitions
Express Scripts and Medco Health Solutions Merger
(Note: the resulting company was named Express Scripts Holding Co., referred to as ESRX through the rest of the article)
Back in 2012, Express Scripts Inc. (the #1 PBM then) acquired Medco Health Solutions Inc. (then #2) in a $29 billion deal to form the largest pharmacy benefits manager in the US, filling a combined 1.4 billion prescriptions a year for employers and insurers. In comparison, CVS currently fills about 750 million prescriptions, which is about half of what ESRX filled in 2012. Being a bigger PBM, ESRX naturally has more bargaining power against drug makers manufacturers, pharmacies, and wholesalers.
SXC Health Solutions And Catalyst Health Solutions Merge To Form Catamaran
Motivated by the successful acquisition of Medco by Express Scripts, another standalone PBM company, Catalyst Health Solutions, was acquired by its rival SXC Health Solutions Corp for a little over $4 billion (during the same year). The combined entity became the fourth-biggest player in the market (by prescription volume) and was later renamed to Catamaran. SXC Health Solutions was originally a software company which provided a technology platform for firms in the PBM industry. They acquired six of the 35 PBM companies that used their platform in 2008 (out of a total of 100 companies in the market). It continued growing at a rapid pace through acquisition and grew revenues from $81 million in 2006 to $10 billion in 2012. The company’s CEO believes that the PBM industry will evolve into a business where participants get paid for information, insights and analytics about prescription drugs that lead to better medical management of patients. [3] Regardless, scale will continue to remain a key advantage in this industry.
This saga of acquisitions is expected to continue in this industry resulting in further consolidation. Consequently, as companies grow larger in size, they will pose a greater threat to CVS’ position in the PBM market.
Rite Aid Poses a Threat to CVS’ Moat
Rite Aid (NYSE: RAD) announced last week that it will acquire EnvisionRx, a national pharmacy benefit management (PBM) company, in a transaction valued at approximately $2 billion. EnvisionRx is a growing business that has seen its sales climb from less than $2 billion in 2011 to an estimated $5 billion in 2015. As Rite Aid gains access to the 13 million individual accounts that EnvisionRx manages [4], it will benefit from the increased negotiating power with drug manufacturers.
Conclusion
Being a pharmacy chain and a PBM at the same time helps companies gain visibility into the demand side of the equation as they negotiate with drug makers for better prices. It also helps boost pharmacy margins for the company to some extent as the PBM assumes responsibility for negotiating prices. CVS has had this unique advantage since the time it entered the PBM market nearly a decade ago. With Rite Aid entering the same league now, CVS looses this key differentiator. But, as the current PBM market is fuelled by a combination of aging population and increased insurance coverage, Rite Aid has external conditions in its favor to narrow down the (huge) gap with CVS. While an immediate impact on CVS might not be seen, we believe that the company has a tough job at its hand to sustain high levels of growth in the long-term.
View Interactive Institutional Research (Powered by Trefis): Global Large Cap | U.S. Mid & Small Cap | European Large & Mid Cap
Other Sources:
Notes:- The Economic Case for Health Care Reform, The White House [↩]
- What is a ‘Pharmacy Benefit Manager?’, The Wall Street Journal, July 21, 2011 [↩]
- Drug Manager Catamaran Can’t Stop Its Takeover Habit, WSJ, February 12, 2013 [↩]
- 6 Ways Rite Aid’s Acquisition Of EnvisionRx Will Take Its Stock Higher, Seeking Alpha, February 11, 2015 [↩]