Why Diplomat Pharmacy Inc Fell Today

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What happened

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Diplomat Pharmacy (NYSE: DPLO) is down 22% at 1:26 p.m. EST Thursday after announcing after the closing bell yesterday that it's acquiring another pharmacy benefit manager (PBM), LDI Integrated Pharmacy Services, for $595 million, including $515 million in cash and another $80 million in stock. The purchase expands on the acquisition of National Pharmaceutical Services (NPS) announced last month, although that was a much smaller $47 million deal. 

So what

It's not necessarily the cost of the deal that has investors hitting the sell button. The acquisition comes with $94 million in tax shields, and management thinks it can generate $4 million to $6 million in cost savings in the first year. Combine those two, and Diplomat is paying a reasonable 11.7 times EBITDA -- and the deal will be accretive to earnings next year.

Investors are likely worried because the acquisition is a major shift away from the company's core business of selling specialty medications. In that business, the main client is the drugmaker that wants to generate as much revenue as possible for its drugs. PBMs, on the other hand, have companies that are self-funded and insurers as their clients, which want to spend as little as possible on drugs for their employees/members.

While the two client bases would seem to be at odds, many PBMs -- including LDI -- already have specialty pharmacies, because distributing the drugs directly can save their clients money by making things more efficient. LDI's specialty pharmacy is small, though, which results in lost sales when the pharmacy doesn't carry the specific drug a patient needs -- and that kind of experience can cause doctors to not send patients to the PBM's pharmacy for traditional drugs.

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From a drugmaker perspective, working with a PBM isn't ideal, but it's a necessary part of the healthcare equation, and drugmakers are willing to concede on price if it means gaining access to patients they wouldn't otherwise be able to sell to. Having a PBM with covered clients could generate more contracts for Diplomat's legacy specialty pharmacy business.

Now what

This shift in strategy comes with unknowns about how it'll affect Diplomat's overall business, so it's understandable that investors are discounting shares today given the added risk.

But if the strategy works, it could disrupt the business model for PBMs going after small clients -- LDI and NPS aren't competing with the big PBMs for big clients -- while maximizing the value for its legacy specialty pharmacy.

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Brian Orelli has no position in any of the stocks mentioned. The Motley Fool recommends Diplomat Pharmacy. The Motley Fool has a disclosure policy.