The key healthcare trend of this decade continues to be vertical integration, connecting the income of health insurance to the outgo of care. Cigna Corporation (NYSE:CI) has been very late to the party, and shareholders are now paying the price.
With rivals UnitedHealth Group Inc (NYSE:UNH) and Aetna Inc (NYSE:AET) having already achieved visibility into drug costs, the former buying Catamaran in 2015, the latter agreeing to be bought by CVS Health Corp (NYSE:CVS) last year, and other insurers having launched their own PBM operations, Cigna wound up paying $67 billion (including debt) for Express Scripts Holding Company (NASDAQ:ESRX).
The good news is that Express Scripts is the largest Pharmacy Benefit Manager (PBM). The bad news is it cost more than Cigna itself was worth, even though ExpressScripts was due to lose the PBM business of Anthem Inc (NYSE:ANTM), which Cigna itself once tried to merger with, as early as next year.
Where Is the Growth?
Cigna’s motives are good. Pharmacy Benefit Managers set formularies and distribute drugs based on prescriptions. They can use their formularies to bargain for better prices, although doctors, patients and drug companies can still insist on the higher-priced “brand name” products.
All health insurers now have their own PBMs, and these captive PBMs will control each insurer’s business. Shares of ExpressScripts had fallen from a high of $92-per-share in 2015 to a low of $57-per-share in 2017 as this coming reality hit the stock.
The fears had not yet hit results, before Cigna came calling. Express Scripts had almost as much revenue in 2017, $100 billion, as in 2015, $101 billion, and $300 million more in profit as well. The price is being sold as a 31% premium over ESRX’s closing price March 7, but only $48.75 is cash. The rest is stock — 0.2434 of a share — whose price fell to $172 on March 8, making the total value closer to $90-per-share. ESRX closed March 8 at $80-per-share, so in theory there may be some profit remaining for arbitrageurs.
The question is, where will the new company get its growth from? Humana Inc (NYSE:HUM) long ago did what Anthem is doing, and created its own PBM. Centene Corp (NYSE:CNC), the largest Medicaid provider, has had its own PBM since 2006.
The battle for new business would seem to center on companies providing Medicaid and Medicare services, as analysts at Decision Resource Group suggested in 2015. Cigna is in the managed care business through HealthSpring, which it bought in 2011 for $3.8 billion. Cigna also has an international business, serving expatriates.
What Comes Next?
The Cigna-Express Scripts deal closes one chapter in healthcare consolidation, and opens the way for the next step, vertical integration of healthcare services.
This was pioneered by managed companies like Centene, which handle Medicare and Medicaid contracts that pay a set annual fee to providers and challenges them to keep costs below that figure.
As a result, Medicare and Medicaid providers long-ago became accustomed to owning clinics, dialysis centers, even surgery centers. This gives them visibility into costs to go along with their incentive to hold costs down. Expect insurers to start down this road with affiliation agreements rather than outright purchases.
Hospital stocks like Tenet Healthcare Corp (NYSE:THC) and HCA Healthcare Inc (NYSE:HCA) have been on fire since 2018 started. Services are going to become the next battlefield in the dance of consolidation between the income of insurance and the outgo of care.
Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he owned no shares in companies mentioned in this article.
