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WIKI ANALYSIS
Express Scripts (NASDAQ: ESRX) is one of North America's top five Pharmacy Benefits Management (PBM) companies measured by prescriptions sold.[1] Express Scripts' clients are health insurers and employers which hire ESRX to manage prescription drug benefit plans for their members and employees. [2] In addition to administering prescription drug plans, ESRX negotiates volume discounts with pharmacies and drug companies on behalf of its clients, and sells drugs at a discount through its mail-order pharmacy.
The merger of CVS and Caremark has increased competition in the PBM market.[3] The merger will likely increase CVS's consumer base. ESRX's revenues will be significantly negatively impacted if CVS increases its consumer base by luring away clients or potential clients from Express Scripts. [4] The Medicare Part D law helps individuals pay for prescription drugs through private providers and has increased the competitive landscape of the PBM market. [5]
ESRX benefits from Baby Boomer aging, who require more medical services as they get older.[6] Also, the key patent expirations on widely used drugs benefit PBMs because they can save money when generic substitutes become available. This is especially true for ESRX, which has the highest generic dispensing rate of all PBMs.[7]
In June 2008, ESRX was selected to be the contractor for the Department of Defense TRICARE pharmacy program, which serves over 9.1 million DoD beneficiaries. The deal is estimated to be worth around $2.8 billion. [8]
Company Overview
Express Scripts is one of North Americas largest PBMs measured by prescriptions sold. More than 50 million Americans rely on Express Scripts for information and treatment to stay healthy. ESRX divides its revenues into two segments; PBM and SAAS. ESRX ended its fiscal year on December 31, 2007, with $18.27 billion in revenues, an increase of $719.6 million from the previous year.
Pharmacy Benefits Management (80.1% of total revenues)
The PBM segment of ESRX is third largest in the US as measured in prescription sales. ESRX buys pharmaceuticals in bulk and resells it to clients at smaller volume and higher price. ESRX distributes pharmaceuticals through a network of third-party retail pharmacies and its own home delivery pharmacies.
The segment generated revenues and operating income of $14.65 billion and $1.04 billion, respectively, in 2007, up from $14.13 billion and $744.4 million, respectively, the previous year.
Retail Pharmacies/Network Revenues (64.6% of total sales in the PBM segment)
ESRX members can purchase drugs from a network of over 60,000 retail pharmacies. ESRX negotiates with these network pharmacies so its members get drugs at discounted prices. ESRX uses electronic processing to manage its network efficiently.
The retail network accounted for 51.8% of ESRX's total revenues in 2007, up 7.6% from the previous year. Two factors -- one positive and one negative -- affected network revenues in 2007, which increased $671.4 million from the previous year. On the up side, network revenues rose by $906.5 million due to inflation and a more expensive mix of drugs being processed (somewhat tempered by an increase in the generic penetration rate). On the other hand, the volume of claims decreased, lowering revenues by $235.1 million. [11]
Home-Delivery Pharmacies (34.2% of total sales in PBM segment)
ESRX operates three home-delivery (or mail-order) pharmacies. ESRX benefits from economies of scale in these mail-order pharmacies. The generic substitution rate is higher in the pharmacies it operates than in the third-party pharmacies in its retail network. ESRX also maintains an inventory of the drugs it buys for its home-delivery pharmacies, providing flexibility to negotiate large purchases and lower prices. ![Revenue as a PBM]](/image/Revenue_as_PBM.jpg)
The home-delivery revenues decreased 2.9% from the previous year. Two factors softened revenues: an increase in generic penetration from 45.7% to 50.5%, lowering the prices of drugs sold, and a $44.2 million decrease in home-delivery claims volume. [13]
Clients
ESRX clients are not the recipients of the drugs it distributes, but rather health maintenance organizations (HMOs), health insurers, third-party administrators, employers, union-sponsored benefit plans, workers compensation plans, primary care physicians, renal dialysis clinics, and government health programs. The business-to-business model spares ESRX the need to market to millions of customers. It also makes the company more vulnerable to the purchasing decisions of individual clients, which each represent a larger portion of sales.
The company has a diverse client base with no single client accounting for over 10% of consolidated revenues the past three years. The top ten retail pharmacy chains account for only 56% of the retail stores in ESRX'S largest retail network. [14] PBM clients generally have a three-year contract, so just one-third of its clients are at risk in renegotiations each year.[15]
Other Services
ESRX's PBM segment offers the following other services to its clients:
- Benefit Design Consultation.
- Patient Care Contact Centers
- Formulary development
- Information Reporting and Analysis Programs
- Rebate Programs
- Electronic Claims Processing System
- Consumer Health and Drug Issues.[16]
Specialty and Ancillary Services (19.9% of total revenues)
This segment generates revenue from delivery and distribution of pharmaceuticals and medical supplies that require special handling and/or packaging, and includes the brands CuraScript SP, CuraScript SD, FreedomFP, and HealthBridge. The SAAS segment of ESRX generated revenues and operating income of $3.62 billion and $23.5 million, respectively, in fiscal 2007, up from revenues of $3.43 billion and down from an operating income of $84.1 million the previous year.
Products and Services
CuraScript SP operates specialty pharmacies in eight states. These pharmacies provide patient care and direct specialty home delivery. Curascript SD offers specialty distribution of medical supplies and pharmaceuticals direct to clinics and providers, provides third-party logistics for pharmaceutical manufacturers, and runs a Group Purchasing Organization (GPO) for a group of its clients. Freedom FP provides fertility services, and HealthBridge provides bio-pharmaceutical services. [17] 
The SAAS segment provides these services:
- Delivery of expensive infused, injectable, oral, or inhaled drugs that have special handling and storage requirements
- Distribution of pharmaceuticals and medical supplies to providers and clinics
- Third-party logistics service for contracted pharmacy clients
- Fertility services
- Bio-pharmaceutical services (including marketing, reimbursement, and logistical solutions)[19]
Clients
The SAAS segment's clients are similar to those in the PBM segment, but also include office-based oncologists, renal dialysis clinics, ambulatory surgery centers, primary care physicians, and retina specialists.
Revenues rose in 2007 in part due to an increase in the cross-selling of ESRX's specialty services to its PBM client and to sales, through its specialty distribution segment, of new drugs that became available in late 2006. Operating income fell for several reasons. Low-margin therapies replaced the sale of higher-margin drugs in several of ESRX's business units. Second, ESRX had inventory write-offs of $9.1 million due mostly to an overstock of flu vaccine after a mild flu season. The company also recorded a $13.5 million non-recurring charge to debt expense in Q3 2007 stemming from the insolvency of a customer.[20]
Trends and Forces
Medicare
The Medicare Part D program lets retirees choose their own prescription medication plans. This has the potential to reduce the number of end users for ESRX's services if employers stop providing their own PBM coverage through ESRX to retirees and instead let retirees pick their own plans. ESRX also faces competition from other PBMs and other healthcare companies, some of which have units that specialize in these Medicare Part D plans. [21] There is also a longer term risk that Medicare might expand and engulf some of the services ESRX provides. This has become more likely as polls suggest that November's elections will yield a House of Representatives, Senate, and White House all under Democratic control.
Demographic Change/Aging Baby Boomers
The PBM sector is positioned to benefit as the aging "Baby-Boomer" population increases the demand for medical services. [22] In 2005 an estimated 19 million Americans were between 65 to 74 years old and 18 million were aged 75 and older; in 2025 these numbers are expected to increase to 35 million people and 26 million people, respectively. [23]
According to a study by the Kaiser Family Foundation, there is a direct correlation between prescription drug use, and spending, age, and the prevalence of chronic, acute, and complex health issues. [24] ESRX will likely benefit from a larger client base and more claims as more people will need pharmaceuticals and as pharmaceutical use per patient increases.
Increase in Number of Generic Substitutes
Generic drug usage has increased over the past several years, and that growth is unlikely to slow in the near future. While generic drugs will likely decrease the company's overall revenues, generics boost ESRX's profit margins and in turn, its operating income. [25] Between 2007 and 2012, over $50 billion worth of branded drugs are expected to lose their patent exclusivity. Among them are Ambien (2007), Adderall XR (2008), and Prevacid (2009). Express Scripts' generic use rates bests those of all other PBMs at 63.2%. [26] ESRX estimates that generic drug users who are commercially insured saved $5.2 billion in 2007 across the industry, so the consumer benefits financially from the switch as well.
Wal-Mart
Wal-Mart has also begun competing with retail pharmacies as it seeks to increase its market share of pharmaceutical sales. On May 5, 2008, Wal-Mart announced phase III of its $4 prescription drug plan; in addition to offering a month's supply of generic drugs for $4 as it had before, Wal-Mart will offer $4 over-the-counter drugs and a 90-day supply of around 350 generic drugs for only $10. However, Wal-Mart offers only a limited selection of drugs, typically, older, generic drugs like ibuprofen, and not all of the drugs that ESRX supplies its customers. This limited offering, Wal-Mart's lack of home-delivery pharmacies, and other strong barriers to entry have prevented Wal-Mart from competing much with ESRX.[27] The other barriers to entry include, but are not limited to, formulary expertise and large networks of retail pharmacies.[28] Still, Wal-Mart's massive buying power and retail stores would create serious competition if it seeks to enter the market against ESRX.
Legislation
States have tried to prohibit health plans from using economic incentives to persuade their members to use home delivery pharmacies. Some states also require that health plans (like those provided by PBMs) cover specific drugs if they are prescribed by a physician. This type of legislation raises costs for PBMs.
Lawmakers and regulators are also considering, or have adopted, changes that would weaken ESRX's ability to negotiate discounts from its network of third-party pharmacies. For example, states have enacted "most-favored nation" legislation that requires pharmacies to give the state the same lowest price it makes available to third-party plans. These requirements hamper ESRX's ability to take advantage of cost savings when it buys drugs in bulk.[29]
The state of Maine and the District of Columbia have enacted statues that declare PBMs to be a fiduciaries with respect to their end users. This means that they must act in the best interests of their clients; for instance, in Maine, ESRX must disclose to its clients the rebates it receives from drug manufacturers. Residents of the states had complained that PBMs were keeping rebates rather than passing them on to their customers. [30]
Competition
As a PBM, ESRX operates in a competitive market against three types of competitors. One type is the independent PBM, such as MedcoHealth Solutions or Catalyst RX. The second type is the PBM owned by a managed-care organization, such as Wellpoint Pharmacy Management or Cigna. And the final type is the PBM owned by a retail pharmacy chain, such as CVS CareMark or Long's Drug Stores.
- Medco Health Solutions -- A PBM traded on the NYSE. It competes with ESRX through mail-order and other traditional PBM services. It has the largest market share in prescriptions sales of any PBM and is the nation's leading PBM based on net revenues, with net revenues of $44.51 million and income of $912 million for fiscal 2007. It operates a mail-order pharmacy and it has a Specialty Pharmacy segment operating under the name Accredo Health Group, which was the largest in the US based on revenues. Medco is an active participant in the Medicare Part D benefit program.[31]
- HealthExtras (HLEX) -- HealthExtras generated 99% of its revenue from its PBM segment in 2007, its PBM segment operates under the brand name Catalyst Rx HealthExtras had revenues of $1.858 billion and income of $39.27 million in fiscal 2007. Its retail pharmacy network includes over 60,000 pharmacies. It provides many of the same services that ESRX does to similar clients. However, one of its clients, Wellmark Blue Cross Blue Shield of Iowa, accounted for 20% of revenues in 2007. Also, their ten largest clients accounted for 58% of its consolidated revenue in 2007. This concentration of revenues amongst a small group of clients will possibly create large problems if it loses some of these clients, ESRX, by comparison has a more diversified client base. [32]
- CVS/Caremark -- CVS is the largest provider of prescriptions and related healthcare services in the US. The March 2007 merger of CVS and Caremark will promote more competition in the PBM sector, especially over time as CVS/Caremark deals with integration problems relating to the companies' merger. CVS operates two segments: retail pharmacy and pharmacy services. The latter is in direct competition with ESRX. This segment provides mail-order pharmacy service, specialty services, plan design, and other services that ESRX also offers. The segment had revenues and operating profit of $34.9 billion and $2.1 billion, respectively, in 2007. The net revenues increase by $29.8 billion due to the acquisition of Caremark in March. [33]
| $, in millions | Total Revenues 2007 | Total Revenues 2006 | Operating Income 2007 | Operating Income 2006 | Network Revenues 2007 | Network Revenues 2006 | Home Delivery Revenues 2007 | Home Delivery Revenues 2006 | Total PBM Claims 2007 | Total PBM Claims 2006 |
| Express Scripts | 18273.6 | 17554.0 | 1061.0 | 825.8 | 9468.8 | 8797.4 | 5015.5 | 5166.0 | 502.3 | 513.9 |
| MedcoHealth Solutions | 44506.2 | 42543.7 | 1392.9 | 888.6 | 26424.1 | 25880.1 | 17537.8 | 16142.5 | 748.3 | 729.3 |
| CVS CareMark | 76329.5 | 43821.4 | 4793.3 | 2441.6 | 26218.9 | 24668.3 | 16790.7 | 15519.4 | 607.2 | 605.9 |
- Wellpoint Pharmacy Management -- Wellpoint is the largest US health benefits company in terms of commercial membership. It divides its operations into three segments; Consumer and Commercial business (CCB), Specialty, Senior and State Sponsored Business (4SB), and Other. Its 4SB segment provides PBM and Specialty services, among other things. It had total revenues of $61.13 billion and income of $3.35 billion in fiscal 2007. It had PBM prescription volume of 392,668,000 in 2007, an increase of 14% from the previous year due to growth in both its retail and mail-order operations after the addition of Medicare Part D. [34]
- Longs Drug Stores -- Longs Drug Stores operates as both a retail drug store and as a PBM, the latter through its Rx America subsidiary. Longs' retail stores have historically been located on the West Coast of the US. Its PBM segment offers prescription drugs under Medicare Part D. It provides many of the same services as ESRX, including mail-order drugs and a retail network of pharmacies (its own). Revenues and net income for the fiscal 2007 (ending January 31) totaled $5.26 billion and $96.2 million, respectively, with its PBM segment accounting for $380 million of revenues or 1.3% of total revenues. Its PBM segment has a small share of the market.[35]
Market Share
The following is a table showing an estimated distribution of the 2006 market share of prescription sales amongst PBMs, managed care organizations, and drug retailers.
References
- ↑ ESRX Annual Earnings Release (10-K) 2007, P. 36-39
- ↑ Reuters report on ESRX
- ↑ [Morningstar analyst report on Express Scripts]
- ↑ Forbes: Caremark Approves CVS Merger revenues.
- ↑ Medicare Part D
- ↑ [Jefferies & Company, Inc. report on ESRX]
- ↑ [Morningstar analyst report on Express Scripts]
- ↑ CNN Money: Express Scripts Rises on Tricare Contract
- ↑ [ESRX Annual Earnings Release (10-K) 2007 P. 37-39]
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 37
- ↑ ESRX Annual Earnings Release (10-K) 2007, P.36
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 37
- ↑ ESRX Annual Earnings Release (10-K) 2007, P.36
- ↑ ESRX Annual Earnings Release (10-K) 2007, P.4
- ↑ Welpoint Annual Earnings (10-K) 2007
- ↑ ESRX Annual Earnings Release (10-K) 2007, P.11
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 39
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 39
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 39
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 39
- ↑ ESRX Annual Earnings Release (10-K) 2007 P. 21
- ↑ Why to Buy Express Scripts
- ↑ National Institute on Aging: US population Aging 65 years or older
- ↑ [Jefferies & Company, Inc. report on ESRX]
- ↑ Morningstar report on Express Scripts
- ↑ WSJ Generics Slow Rise of Drug Spending
- ↑ Walmart Press Release
- ↑ WSJ Should PBM Investors Worry About Wal-Mart?
- ↑ ESRX Quarterly Earnings Release (10-Q) Q1 2008
- ↑ The future of PBMs -- a work in progress
- ↑ Medco Annual Earnings (10-K) 2007
- ↑ HLEX Annual Earnings (10-K) 2007
- ↑ CVS Annual Earnings (10-K) 2007
- ↑ Welpoint Annual Earnings (10-K) 2007
- ↑ Longs Drug Stores Annual Earnings (10-K) 2007
- ↑ CIBC World Markets: Express Scripts
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