What’s bad news for Big Pharma but good news for pharmacy benefit management companies? The fo impending loss of patent protection on some of this country’s biggest selling drugs.
The big PBMs are chomping at the bit, waiting eagerly for Pfizer’s (NYSE:PFE) big cholesterol drug Lipitor to go generic later this year. That’s because blockbuster generics are highly profitable for PBMs, especially those delivered through their extensive mail-order pharmacies.
Three public companies currently dominate the PBM market: Express Scripts (Nasdaq:ESRX), CVS/Caremark (NYSE:CVS) and MedcoHealth (NYSE:MHS). An industry group estimates that together they account for more than 35% of the market, with Express Scripts the leader at about 13.5%.
The number of top-selling drugs slated to go generic during the next several years is just one reason to be enthusiastic about the prospects for the PBMs. Others include the growing role of prescription drugs as the first line of treatment for many medical conditions, the expansion of health care to greater numbers of people, and the aging population with its impending retirement of the baby boomers.
Also, proving that size does matter, the big three in the industry might be able to extract deeper discounts from drug manufacturers and retailers, forcing a consolidation among the smaller players.
That may have been the reason Walgreen (NYSE:WAG) recently jettisoned its relatively small PBM, selling the unit to Catalyst Health (Nasdaq:CHSI). Even with the additional Walgreen business, Catalyst will have only a 5% share.
One analyst said the Walgreen sale signals to investors that it doesn’t make sense for a retail pharmacy to own a PBM. CVS Caremark may be leaning in that direction after reporting that its pharmacy services business declined more than 6% in 2010. One has to wonder if the unit’s tepid results is one reason the company’s share price is down about 10% from its 52-week high of $37.82.
MedcoHealth shares have also suffered, but for another reason. After a more than 40% price jump from September 2010 to mid-January 2011, Medco has recently headed south. In less than three weeks, the stock has dipped to $52.45 from $64.35.
Alleged hanky-panky involving a key customer certainly has something to do with the nosedive. Calpers, the California state pension fund, recently declined to sign a new contract with Medco as it looks into “possible improprieties” in the signing of its last contract. One analyst estimated that the Calpers contract will cost MedcoHealth about 3 to 5 cents of EPS, but said the damage to the company’s reputation could weigh disproportionately on its shares.
The picture is brighter for industry leader Express Scripts. Its share price has just about doubled in the past year, closing at $52.05 on Monday. Some say the run may be losing steam and express caution about buying the stock now. Analysts following the company seem to agree; the last three have downgraded the stock to two holds and a market perform.
An even better bet for investors sold on the future of PBMs but seeking broader health care coverage might be the ETF iShares Dow Jones US Healthcare Provider (NYSE:IHF) exchange-traded fund. More than 16% of its assets are in Express Scripts and Medco.
At the time of publication, Barry Cohen did not hold shares in any of the stocks named in this article.
