Express Scripts Holding Co. (ESRX, Financial) is the largest pharmacy benefits manager in the United States, processing over 1.4 billion prescriptions a year through its own pharmacy as well as its network of retail pharmacies.
This structure gives the company pricing power and economies of scale that even Amazon’s (AMZN, Financial) new PillPack subsidiary won’t be able to compete with for some time. With the aging population in the U.S., it’s apparent that health care spending will only increase in the coming years. As that happens, patients will turn to pharmacy benefits managers to help them control spending.
Amazon may be the most successful retailer, but any new competitor entering into this industry will need to deal with multiple large and powerful market leaders. The true end customer in the pharmaceutical space is not the consumer, but rather the insurer, employer or government that pays for the health benefits.
Amazon may be able to disrupt it, but it is highly unlikely to do so to the same degree it did in retail. More importantly, the expertise needed to profitably navigate the space puts a massive barrier to entry around the current market leaders, who all have solid economic moats.
That being said, there is some bad news on the horizon that may hurt the company financially. Its largest client, Anthem (ANTM, Financial), will not renew its contract in 2020, especially if its $67 billion merger with Cigna (CI, Financial) goes through. All its strengths will not matter to shareholders if the Department of Justice approves the deal. The current terms have shareholders receiving $48.75 in cash and 0.2434 shares of the combined entity, with Express Scripts shareholders looking to own 36% of the company. The union still needs regulatory and shareholder approval, but the deal could close by the end of the year.
Aside from creating a more complete and accessible health care solutions provider, with greater reach and a larger customer base, the new company will generate over $7 billion in net profit. At 15 times earnings, that would be an $105 billion market cap, about 56% higher than the deal value, but only 20% higher than the combined market value of both companies.
The good news is the government's extensive contracts for employee health insurance plans mean the Cigna-Express Scripts merger will likely be approved by the Justice Department. Shareholders are voting on the deal on Aug. 24 in West Hartford, Connecticut. The deal will help the company more effectively compete with CVS (CVS, Financial) and Aetna (AET, Financial), who are also merging, something the marketplace desperately needs.
Even without the merger, though, Express Scripts is a bargain trading below 10 times earnings. The fact Cigna wants to buy the company just puts that even more in focus.
Disclosure: I am not long or short any stocks mentioned in this article.
