After Anthem (NYSE: ANTM)threatened to stop doing business with pharmacy benefit manager Express Scripts (NASDAQ: ESRX), shares of the PBM sank. Can Express Scripts survive the loss of its biggest customer?
In this clip from the Motley Fool's Industry Focus: Healthcare podcast, analyst Kristine Harjes and contributor Todd Campbell discuss why these two healthcare titans are battling and what could end up happening if the two don't call a truce.
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A full transcript follows the video.
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This video was recorded on April 26, 2017.
Kristine Harjes:We have some news to dig intoregarding one of the nation's major PBMs, but first, I figurewe should give some background on what exactly is a PBM?Todd Campbell:To keep it very top leveland make it very easy to understand, each one of these payers, insurers, or it could be a company that self-insures theiremployees,has to go out individually and negotiate with drugmakers on pricing. That'snot very efficient. You'renot likely to get the best deal, because you don't have a lot of bargaining power. So what PBMs do isallow a lot of different insurers and different payers to bondtogether under this umbrella, and they'llnegotiate the best price for you, pass along that savings to you, andtake a small piece for themselves.Harjes:Right. They'rebasically leveraging their size totry to get prices down, and they take a cut of those savings. Because of that, they've beenpainted in a sketchy lightlately, especially by drugmakers, saying, "We're not responsible forastronomical drug prices; it's actually the PBMs." I don't know,I think they've been kind of successful intainting the reputation of PBMs. Thatmight not even be the right way to phrase it,because I don't think they had a reputationbefore people really started thinking about this issue.Campbell:Yeah, Kristine,I think a few years ago, they were being looked at aspart of the solution. I think the drug industry haspainted them now as part of the problem, andthey've done a pretty good job marketing that to individuals.Harjes:Yeah. It'sinteresting. Personally, I don't know what my opinion is on whether they're good guys or not, but I think it's important to understand that they are part of this whole relationship, and they're just one more cog in the wheel, they're one more piece of this puzzle, and they're going to take a cut. So they are part of the equation of why drug prices are the way they are, for better or for worse.Campbell:Yeah. The argument would be that they have to save you more, and they're only taking a cut of what those savings would be, so if they didn't exist, the cost would be higher. That would be the counter-argument, and the value they add. But maybe the value they're addingisn't as great as it sounds, at least according to Anthem.Harjes:Exactly. That brings us to the news-y part of the segment,and why we wanted to address this to begin with.Express Scripts, which isone of the major United States PBMs,lost about 12% of their stock priceyesterday, Tuesday, on the news thatAnthem, which is one of the big health insurers, is notplanning on renewing its contracts that it had withExpress Scriptswhen they get to their expiration in 2019.Campbell:This is an ongoing battle between Anthem andExpress Scripts that's been going on more than a year.Harjes:Yeah. It was the very first thing that Express Scripts addressed in their earnings call. They basically said, "This is the latest on this deal, Anthem has signaled to us that there is no way we can reach a compromise, so they're not going to renew their contracts." Express Scripts, to their credit, wasextremely transparent about exactly what will happenfinancially when/if theylose this as well as some other big clients. Anthem, in general, has been verypushy about demanding things from Express Scripts. They wantExpress Scripts to give them $3 billion a yearin order to keep this contract. WhenExpress Scripts opened up their books and said, "Look,this is how much money we're making from this deal,this is what you're asking for," it just wasn'tpossible to make those ends meet.Campbell:Yeah. This all beganback in 2009, when Anthem sold theirinternal PBM business toExpress Scripts and, at the time, inked a 10-year deal forExpress Scripts to handle this part of the business for them.Harjes:Right, hence the2019 expiration.Campbell:Yeah. Aspart of that language, they were supposed to be able to get someprice rebating backat the end of the year. They had been projecting that to be a fairly large sum. Last year, Anthem came out and said, "Listen, we thinkExpress Scripts is charging us $3 billion a year too much forthe drug that it's handling. They'renot passing those savings along to us thatthey have promised to pass along." Shortly thereafter, Anthem filed a lawsuit, saying to Express Scripts, "Either pay up or we're going to walk away. Give us the option, either or." Obviously, the twocould not find a middle ground on this, and that's what promptedExpress Scripts, finally, to say on their earnings call, "Listen,they told us they'renot going to renew in 2019, and that means we'regoing to lose a big chunk of our EBITDA." Toput that in perspective forinvestors on why this wassuch a big deal and caused shares to plummet, last year, Anthem's businessrepresented almost a third ofExpress Scripts' EBITDA. So this isvery substantial, their biggest customer, verysubstantial part of the business. No wonderinvestors were like, "Oh my God,what's going on, what's going to happen in a few years?"Harjes:Right.Express Scripts' stock hassuffered pretty considerably because of this. They're down about 30% since the fighting with Anthem began. If youlook at the aftermath and what'sactually going to happen, it'll take a little bit of timeto be fully felt. WhenAnthem first came to Express Scripts, back in 2009, as you were saying, it took three full years for thetransition. Even post-2019, theimpact won't be immediate. But still, it will bereally difficult to replace this business. I can't imagine what other health insurerExpress Scripts might try to forge a deal to replace what they'relosing with Anthem. You haveUnitedHealthcare, that's a huge insurer, but they have their ownPBM.Humanahas its own,Cignahas a 10-year contract withCatamaran,which was acquired by UNH. Then,Aetnahas a contract with [CVS Health], which also has a PBM thatexpires in 2019. So that could bekind of interesting.Campbell:Yeah, this is an area where there arealways companies in payers moving back and forth,but it's usually not the big ones. It's usually not the players like Anthem.Harjes:Right,because they're long-term contracts.Campbell:Yeah. Now, I think you mightlook at the shares today,if you're listening to this on the day we record here, and say, "But shares are up." That'sbecause there was some conversation on Anthem'sinvestor call today thatindicated that maybe the door was still open for somenegotiation. Obviously,Express Scripts doesn't want to give Anthemall the money that Anthem wants, Anthem seems to want that money,I don't know where they would find a middle ground. But it's giving a little bit ofsupport after that big drop in shares today, at least.Harjes:Right.Express Scripts has made it very clear that they'restill willing to negotiate. It seems like Anthem is playing hardball here, butI honestly wouldn't be shocked if Anthemended up finding some way to compromise.Campbell:One of the takeaways here, Kristine, for investors should be,always be a little bit cautious whenone customer accounts for a very big percentage of a company's business. Right?Harjes:Absolutely, that's a great takeaway. Thatsinglerisk factor is not something to be discounted.Campbell:Now,that doesn't mean that you can't go in andmake some money on Express Scripts.I think there's still a need for abusiness like Express Scripts. The debate would be, is Express Scripts the biggest player in the PBM business? Or the best player,I should say,from here in the PBM business? Maybe CVS is the best player because they have the most gain.Harjes:Yeah. If CVS won Anthem,that would certainly make them the biggest PBM.Campbell:Yeah. Youalso have the potential for UnitedHealthcare, which isobviously a lot more diversified because it runs its own PBM,but it'salso the largest health insurer as well. Aninvestor might not want to own a PBM and a separate health insurer in their portfolio, they want a combination of the two, thenUnitedHealthcare fits the bill in that way.
Kristine Harjes has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. The Motley Fool owns shares of Express Scripts. The Motley Fool recommends CVS Health and UnitedHealth Group. The Motley Fool has a disclosure policy.