The merger of Express Scripts and Medco showcases how aggressive competition has become to best streamline the drug delivery business. A bigger PBM has more clout in negotiations with pharmaceutical providers, making mega-managers increasingly attractive to larger clients. The economics are pretty compelling, too. According to the companies’ joint statement: “Due diligence to date has identified estimated synergies of $1 billion once fully integrated.”
The creation of companies like CVS-Caremark and Express Scripts-Medco is only the beginning of strategics’ ambition for the PBM space. For example, UnitedHealth will push its services subsidiary Optum further into the drug benefits management space. Part of Optum’s growth had UnitedHealth terminating a PBM contract it had with Medco, costing the benefits manager a substantial portion of its business. At the same time UnitedHealth was ramping up its PBM ambitions, Optum’s CEO, Mike Mikan, left to join an unnamed private equity firm. United wouldn’t provide specifics on where Mikan headed, but other buyside opportunities must abound, in his view.
What could drive a corporate CEO away from a successful and expanding division? Strategics will see their consolidation plays challenged by regulators, lawmakers and lobbyists— their M&A pace may be dictated by Washington more than by their balance sheets. The Express Scripts deal was almost immediately challenged because the Medco deal will give it commanding market share. The transaction also generates immediate dealmaking opportunities: Express Scripts will have to divest one mail order dispensing facility, another specialty pharmacy business, and $115 million in contracts to satisfy FTC requirements.
While companies like Caremark and Express Scripts struggle to justify to regulators their ambition to scale operations, private equity firms will have an opportunity to acquire smaller PBMs as the corner pharmacy is made increasingly obsolete. Building regional platforms would allow PE investors to develop revenue streams through client bases Express Scripts is less inclined to pursue, and keep beneath regulators’ radar at the same time.
Private equity professionals will have to carefully target their market. Medco also saw its top line take a hit in the wake of disclosures it paid millions to former CalPERS executive Alfred Villalobos, when the company lost its lucrative drug benefit contract with the pension. Caremark wound up with CalPERS’ business—it is quite possible that the contracts lost by Medco in recent months is what pushed it into a merger. Financial sponsors should tune into pensions’ (and other large groups of insured patients’) negotiations with prescription benefits managers. If a PBM business suddenly sees a large chunk of its revenue switch providers, consolidation might be their only option. As benefits managers’ clout with drug providers continues to grow, PE should expect to enjoy a smaller margin, however.