As the Express Scripts-Medco Health Solutions merger draws closer to getting the FTC approval, the market is weighing the implications for Walgreen (NYSE:WAG). The drug retailer walked out of Express Scripts network last year over disagreements on reimbursement rates, losing over $4 billion worth of business. Would it risk losing more prescription business if Medco folds into Express Scripts?
During the latest earnings call, Walgreen’s management said it hopes to maintain its relationship and existing long-term contracts with Medco, unless the new company took “an extraordinary action” to terminate the existing contracts or significantly modify the terms of the agreements. Meanwhile, there are fresh rumors that Walgreen may also enter into a fresh deal with Express Scripts soon, which would definitely be good news for the drug retailer. (Read If Express-Medco Merge, New Walgreen Deal In The Offing?) Walgreen competes with CVS Caremark (NYSE:CVS) and Rite Aid (NYSE:RAD).
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Express-Medco Merger and Implications for Walgreen
The U.S.’s two largest PBMs, Express Scripts and Medco, are attempting to merge and there is increasing likelihood that the merger could soon receive the FTC approval despite anti-trust concerns. The resulting entity would then control around 34% market share, handling prescriptions for about 135 million customers. The consolidation would also greatly increase their pricing power over drug manufacturers and drug retailers.
In 2011, Walgreen parted ways with Express Scripts citing long-term interest and not agreeing to lower reimbursement rates offered by Express, letting go of more than 80 million prescriptions worth $4 billion business. With the merger appearing more and more likely, the market is now weighing the possibility of Walgreen’s similar hostile reimbursement rate negotiation with Medco.
How Much Business Does Medco Bring To Walgreen
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. This clearly means that Medco brings significant business to Walgreen stores.
The number of Medco’s prescriptions filled at Walgreen stores is however likely to decline to 108 million prescriptions in 2012 and further shrink to 74 million in 2013, as some health plans like UnitedHealth Group are expected to migrate out of Medco.
Nonetheless, Medco is one of Walgreen’s largest customers, and the drug retailer cannot afford to lose more prescriptions business. Some analysts also speculate that Walgreen may be contemplating a bid for Rite Aid to strengthen its bargaining position, though some believe it may not happen anytime soon or at all. We don’t have strong conviction on whether a bid will be made but note that consolidation and scale could help Walgreen’s competitive position.
Management Remains Positive
Despite the risks, the company management hopes to maintain its relationship and existing long-term contracts with Medco and expects to see flexibility in retaining access to Medco’s clients if a merger with Express Scripts were to happen. Based on its interaction with major health plans and employers, it believes that Medco’s clients have greater control to keep Walgreen in their network than Express Scripts’ customers.
We currently value Walgreen with a $35 Trefis price estimate of its stock, which is almost in-line with the current market price.