With the Express Scripts (NYSE:ESRX) – Medco (NYSE:MHS) merger winning FTC approval to create a PBM giant with one-third market share, there could be implications for the drug retail giant Walgreen (NYSE:WAG). At stake, is the business it does with Medco, after having parted ways with Express Scripts. There are also expectations that Walgreen may give another shot to mending ties with the estranged Express Scripts. The merger has realigned the industry dynamics and the drug retailers hoping to improve push up margins through generics expansion may feel more heat on their bottom-line with tougher negotiations over reimbursement rates. Walgreen competes with CVS Caremark (NYSE:CVS) and Rite Aid (NYSE:RAD).
What Does The Merger Mean
Despite anti-trust concerns, the merger deal combining two of the U.S.’s three largest Pharmacy Benefit Managers got approved by the FTC, which voted for it 3 to 1. It now creates a company that will handle the prescriptions for more than 115 million people, dispensing one third of all prescriptions filled in the U.S.
While Express Scripts’ strength lies in middle-market plan sponsors clients, Medco focuses on high-volume, large employers. The combined entity would also control 60% of the market for mail-order drugs. The decision came despite several months of intense lobbying by other PBMs and independent pharmacies, complaining the deal would create an anti-competitive monopoly over the flow of prescription drug benefits.
Walgreen’s Business With Medco and Express-Scripts
In 2011, Walgreen parted ways with Express Scripts citing long-term interest in not agreeing to lower reimbursement rates offered by Express, letting go of more than 80 million prescriptions worth $4 billion business. With Medco now folding into Express Scripts, there are obvious concerns about future of Walgreen’s contracts with Medco. Medco represented around 125 million prescriptions for Walgreen in 2011, compared to 90 million prescriptions associated with Express Scripts. Overall, Walgreen filled close to 716 million prescriptions in 2011, with Medco and Express making up 17.5% and 12.5% of Walgreen’s prescription market share during the year, together bringing huge prescription business to Walgreen stores.
Medco’s existing contract with Walgreen is believed to be better than the old Express Scripts contract and Walgreen says it hopes to maintain its relationship and existing long-term contracts with Medco. Nonetheless, it faces challenges and risks over the future of its prescription business from Express-Medco and needs to be very careful in negotiating its business terms with them going forward. There could certainly be heavier reimbursement rate pressure, threatening to weigh on the margins but the drug retailer cannot afford to lose more business, especially from Medco. Analysts believe it is less likely that Walgreen would be dropped from the combined network, as there are no indications of that so far.
It would even make more sense for Express Scripts to make up with Walgreen, which would be in the interests of both the U.S.’s largest drug retailer and the largest pharmacy services provider. There are rumors that Express and Walgreen may soon renegotiate a fresh deal. If that happens, it would also be good news for the Walgreen stock that currently trades at $35, having lost almost a quarter of its value since its impasse with Express Scripts in June 2011. UBS expects the deal as soon as April or May and even raised its price target for Walgreen to $39.  (Read If Express-Medco Merge, New Walgreen Deal In The Offing?)
We currently value Walgreen with a $35 Trefis price estimate of its stock, which is almost in-line with the current market price.Notes:
- Walgreen’s Target, Estimates Boosted at UBS (WAG), Dividend.com, March 2012 [↩]