Rite Aid Enters The Pharmacy Benefit Management Market With EnvisionRx Acquisition

Rite Aid (NYSE: RAD) announced last week that it would acquire EnvisionRx, a national pharmacy benefit management (PBM) company, in a transaction valued at approximately $2 billion. The company will pay 90% of the amount in cash and 10% in Rite Aid stock (approximately 27.9 million shares). The company expects to realize significant synergies as it gains access to millions of individuals that EnvisionRx manages, in addition to gaining access to specialty pharmacy and mail-order channels. With projected 2015 calendar year revenues of approximately $5 billion and projected 2015 calendar year EBITDA of $150 to $160 million, EnvisionRx will provide a boost to the company’s earnings. Rite Aid becomes only the second drugstore chain to also own a PBM services arm, after CVS Health (NYSE:CVS), which bought Caremark Rx for $21 billion nearly a decade ago to enter the PBM market.

Rite Aid’s stock price has jumped up by 10% since the news release, as the market believes that the acquisition will accelerate the company’s growth. Below, we take a look at different ways in which Rite Aid is going to benefit from the transaction.

Our price estimate of $6.27 for Rite Aid is approximately 25% lower than the current market price of $8.34.

View our detailed analysis for Rite Aid

Some Background on Pharmacy Benefit Management

Pharmacy benefit managers, or PBMs, act as an intermediary 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, some of it becomes the PBM’s earnings. So, essentially, the larger a PBM’s customer base, higher is its negotiating power and higher are the savings for the company (and its customers). ^[1]

How Will This Acquisition Help Rite Aid?

Better Negotiating Power With Drug Makers

In terms of revenues, Express Scripts (NASDAQ: ESRX) and CVS Health are the two largest PBMs in the US, with revenues of about $105 billion and $88 billion (pharmacy services only), respectively. On the other hand, EnvisionRx’s revenue of $5 billion is rather insignificant compared to that of the top 2 companies. But, it 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 ^[2], it will benefit from the increased negotiating power with drug manufacturers. With low reimbursement rates continuing to put pressure on margins, it becomes increasingly important for drugstores to minimize costs, not only to boost the company’s profits, but also to lower out-of-pocket costs for their customers.

Existing Retail Business To Benefit From PBM

The PBM business is also likely to boost Rite Aid’s pharmacy retail business, as a portion of the company’s PBM accounts would gravitate towards Rite Aid to get their prescriptions filled (~40% of CVS’ PBM prescriptions go through its own channels). ((Annual Analyst Day 2014, CVS Health Events, December 16, 2014)) Moreover, margins in the pharmacy retail business are much higher than those in the PBM business. For example, CVS’ makes an EBITDA margin of about 16% in its retail business, compared to a little over 5% in PBM (based on 2014 results). So, as more and more PBM customers go to Rite Aid’s stores to fill their prescriptions, retail will form a larger portion of the revenue and help improve the overall margin. (Note that Rite Aid also has to integrate Envision with its drugstore operations, which could weigh on margins in the short term)

Access to The High-Growth Specialty Pharmacy  Market

Specialty drugs treat complex diseases such as multiple sclerosis, rheumatoid arthritis, hepatitis C and cancer, among others. Because of the specialized way in which these drugs need to be administered, specialty pharmacies play an important role in providing the support required to effectively deliver these drugs to patients. According to a Drug Channel Institute report, in 2018, six of the ten best-selling drugs by revenue are projected to be specialty drugs, compared with three drugs in 2010 and five in 2012. As these drugs are characterized by high cost and high complexity, this holds a lot of growth potential for retailers with the necessary delivery and support systems. This is another way in which this acquisition opens up Rite Aid to bigger opportunities.

Source ^[3]

Conclusion

Although, the above mentioned synergies are expected to significantly boost Rite Aid’s top line and bottom line, much will depend on how well and how quickly the company can integrate EnvisionRx with its operations. Rite Aid’s previous acquisition did not turn out to be great as it led to a string of losses and eventually, to the launch of an aggressive cost-cutting campaign. However, unlike the external conditions during the previous acquisition (during the Great Recession), at present, the healthcare industry has many factors going in its favor (an aging population, healthcare reforms, etc.) and most drugstore chains are investing in expanding their offerings. We believe that this acquisition is a big stride for Rite Aid in its transformation from a loss-making drugstore chain to an integrated retail healthcare service provider.

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Other Sources:

• Rite Aid Newsroom
• The Motley Fool

1. What is a ‘Pharmacy Benefit Manager?’, The Wall Street Journal, July 21, 2011 [↩]
2. 6 Ways Rite Aid’s Acquisition Of EnvisionRx Will Take Its Stock Higher, Seeking Alpha, February 11, 2015 [↩]
3. Annual Analyst Day 2014,CVS Health Events,December 16, 2014 [↩]