Last year was blah for Express Scripts Holding Company (NASDAQ ESRX) shareholders. The giant pharmacy benefit manager’s stock turned in 3% gain well below the 21% jump from the previous year. After just a few weeks of the New Year, though, investors might already be nostalgic for blah. Express Scripts shares have plunged over 14% in January so far. Could 2016 be the PBM’s worst year yet?
A bad case of the blues
It only took a few minutes to turn 2016 into a very unhappy New Year for Express Scripts. Joseph Swedish, CEO of Anthem (NYSE ANTM), spoke on Jan. 12 at the J.P. Morgan Healthcare Conference. The last portion of his presentation focused on the contract between Anthem, which operates Blue Cross and Blue Shield plans in 14 states, and Express Scripts.
Anthem sold its internal PBM to Express Scripts in 2009 and signed a 10-year contract. The agreement contained a provision that allowed for repricing effective Dec. 1, 2015. Talks about this repricing have hit a major obstacle: Anthem wants savings of around $3 billion per year — and Express Scripts is balking at that amount.
From Anthem’s perspective, Express Scripts has been pocketing significant savings that it has made from negotiating with pharmaceutical companies. Express Scripts doesn’t have an issue with a pricing review, but the PBM thinks the amount floated by Anthem isn’t justified.
What would it mean if the two sides don’t come to an agreement? Anthem could try to find another PBM. If the dispute ends in a parting of ways, it would be a huge blow for Express Scripts. Anthem is the company’s largest customer, making up 14% of Express Scripts’ revenue in 2014.
But there’s also an enormous impact if Express Scripts gives Anthem what it’s asking for. In December, Express Scripts announced its 2016 financial guidance. That guidance called for earnings before interest, taxes, depreciation, and amortization (EBITDA) of $7.23 billion to $7.43 billion. Paying out $3 billion more to Anthem would wreak havoc on that forecast.
Of course, there’s still a chance that the two companies reach a compromise solution. Even if they settle, it seems likely that Express Scripts will see lower earnings than it expected for 2016. On the positive side, Express Scripts could benefit over the long run if Anthem ultimately renews the contract with Express Scripts and swings Cigna‘s (NYSE:CI) business its way. Anthem announced that it would buy Cigna in July 2015. However, Cigna is locked into a contract with Catamaran, which is now part of UnitedHealth‘s (NYSE UNH) OptumRx, until 2023.
Worst year ever?
What would it take for 2016 to be the worst year ever for Express Scripts? In 2008, the PBM’s stock plunged nearly 25%. The Anthem debacle has caused Express Scripts shares to fall nearly half that amount in a matter of days.
Whether this year becomes the worst yet for Express Scripts depends largely on the outcome of the Anthem contract negotiations. I don’t see Express Scripts ponying up $3 billion — nearly half of its expected 2016 EBITDA. As important as Anthem’s business is, that’s too hefty a price tag.
However, I also think it’s in Anthem’s best interest to strike a deal. There aren’t many PBMs that could handle its size — and one of them is owned by UnitedHealth, a direct competitor of Anthem. Maybe Anthem’s long-term strategy is to create its own PBM, but that takes time and would be tricky to pull off with a simultaneous acquisition of Cigna. There’s also the question of whether any PBM would agree to the pricing that Anthem wants.
My view is that 2016 could very well be the worst yet for Express Scripts but only if the overall market enters serious bear territory and not solely because of the Anthem situation. After all, Express Scripts’ stock has already fallen roughly the same percentage as the amount of revenue that the PBM generates from the Anthem business. The bad news over the potential loss of this contract seems to already be baked into Express Scripts’ share price. That might be the best news to be found for Express Scripts investors right now.
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Date: January 25, 2016