Could Express Scripts Reach $100 This Year?
Helen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
An aging population makes the healthcare industry one that will continue to grow despite other economic trends. Within the industry are several ways to play it; equipment manufacturers, service providers, drug companies, or pharmacy benefit managers. I think the benefit managers offer the best ability for some long term growth. Below I will talk about Express Scripts (NASDAQ: ESRX) and why I think it should be added to portfolios looking for sustained long term growth.
Express Scripts is one of the largest pharmacy benefits managers in America. It competes directly against companies such as Medco Health Solutions (UNKNOWN: MHS.DL), Catalyst RX (UNKNOWN: CHSI.DL), and MedImpact. In addition to pure managers it competes against other insurance companies with pharmacy segments or retail pharmacies such as Aetna, CIGNA, CVS Caremark, and Walgreens.
In its latest 10-Q Express Scripts reports its two largest customers as Wellpoint (WLP) and the U.S. Department of Defense (DoD) at 29.9% and 21.3% of revenues respectively. The other big three make up 6.2% of revenues. The total for these five biggest customers is 57.4% of revenues. It notes that it just renewed its contract with the DoD in 2009. Looking at the trend for the last few years, it doesn’t look like the loss of Walgreens has had any material impact on the bottom line. Where the loss does hurt is that Walgreens has now teamed up with Catalyst RX and could help Catalyst grow and become a bigger threat to Express Scripts.
In that same document it also mentions a merger agreement with Medco Health Solutions that was entered into. The merger is supposed to close here in the next few months. Express Scripts and Medco could actually close on the agreement now as the FTC hasn’t told them no within the prescribed waiting period. But according to the associated press the two companies are waiting to give the FTC ample time to review everything and approve the merger. This would more than double Express Scripts’s annual revenue and double its market cap. It could create a behemoth pharmacy benefit manager with a market cap over $50 billion and annual revenues over $100 billion.
The belief on the street is that the merger is going to be approved as shares of both companies have grown substantially since no negative words have come from the FTC yet. While some people think this would create a non-competitive environment and should be denied as such, I think it’s a decent idea. With all the publicity lately on rising drug costs, this merger would give access to unprecedented quantity buys and quantity discounts. This would allow the new company to pass those discounts to its customers and help lower drug costs. A key to that would be monitoring by the FTC to make sure those discounts are actually passed along instead of put into the pockets of corporate executives. Medco just lost a major contract with United Health Group which was about 17% of its revenues. Without the merger Medco would have to make up for that contract which expires in December of this year according to its latest 10-Q.
MedImpact is privately held so figures for them weren’t available for research. According to its website MedImpact boasts over 35 million customers. It also claims to be the largest “full-service Pharmacy Benefit Manager (PBM) that derives revenue by managing the drug benefit, not from dispensing drugs.” Catalyst is a baby with a market cap of just under $3 billion and revenues of just over $5 billion. It was named by Fortune as one of the fastest growing and most admired companies. Since it just picked up the Walgreens deal from Express Scripts, I wonder if it might try and go after the United Health Group contract. That contract would be north of $10 billion based on the percentage of revenue that Medco reports it as. If it truly is the fastest growing, picking that up would increase revenues by over 200%. Catalysts P/E ratio is around 44 while Express Scripts and Medco’s are around 20.
A look at the available balance sheets shows debt to equity ratios of 0.7 for Medco, 3.3 for Express Scripts, and 0.3 for Catalyst. The Express Scripts/Medco deal called for about $28 in cash and 0.81 shares of Express Scripts stock for each share of Medco which will end up being about $11 billion in cash. With only $5 billion on the books this means Express Scripts will have to take on a chunk of debt to help finance this deal. It will also be absorbing $5 billion of debt from Medco. After this is all said and done it could put the total debt on Express Scripts’s books near the $15-$20 billion dollar range. The merger would provide about $4 billion in free cash flow as things are now.
I think with synergies and other efficiencies the new company could get that cash flow up near $6 billion a year. Since the FTC would likely block any more acquisitions by the new company, one has to be curious about what it could do with the extra cash flow. I think we could see a dividend by the end of 2013 or 2014 once the integration is completed and the company has a better idea of the new cash flow.
Express Scripts is a solid hold at this point. I like the company and everything about it. If the FTC was to deny the merger, shares would get overly beat up. There is still a good upside here, especially if the merger goes through, but recent buying on speculation has created a big a down side risk. Without the merger, shares are worth about $55-$60 and could see that by the end of 2012, after the merger I think shares could see $70 for 2012. Once the synergies and things start to show in the numbers, I think shares could see $100 by the end of 2013.
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