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We continue to have a Neutral recommendation on Express Scripts Inc. (ESRX - Analyst Report) with a target price of $57.00. The company functions under two segments: Pharmacy Benefit Management (PBM) and Emerging Markets (EM).
With the intention of growing its PBM business, Express Scripts completed two acquisitions over the past few years. In July 2008, the company acquired the Pharmacy Services Division of Medical Services Company. Medical Services Company was a leader in providing PBM services to clients providing workers compensation benefits.
In December 2009, Express Scripts acquired NextRx, WellPoint Inc.’s (WLP - Analyst Report) PBM segment. The deal, which significantly expanded Express Scripts’ PBM business, also included a 10-year contract under which Express Scripts will provide PBM services to WellPoint and its designated affiliates.
Moreover, in July 2011, Express Scripts announced its intention to acquire healthcare company Medco Health Solutions, Inc. for $29.1 billion in cash and stock. We believe this acquisition, which is expected to close in the second quarter of 2012, will generate more synergies for the two PBMs and help lower the cost of prescription drugs.
Express Scripts stands to benefit from increased generic utilization, shift toward mail orders, strong specialty growth and an aging population. The use of generic drugs should increase significantly over the next few years as several branded prescription drugs are scheduled to lose patent protection, including Pfizer Inc.’s (PFE - Analyst Report) Lipitor (November 2011). Increased generic uptake and higher use of mail orders should help the company improve its margins and profitability.
Additionally, we believe Express Scripts is well positioned to benefit from healthcare reform initiatives like broader insurance coverage, the potential approval of a pathway for biosimilars and incentives supporting the utilization of information technology systems. The implementation of these initiatives should help drive growth at Express Scripts.
We are, however, concerned about the company’s dependence on a small number of customers for a significant part of its revenues. The top five clients of Express Scripts collectively represented 56.7%, 55.2% and 23.7% of revenues during 2011, 2010 and 2009, respectively. Considering that this percentage has been increasing each year, the loss of a significant customer would have an adverse impact on the company’s revenues and operations.
Moreover, Express Scripts and WellPoint are in a contractual dispute regarding the terms of the PBM agreement, which the companies had inked in December 2009. In December 2011, WellPoint said that it differs from Express Scripts on the contractual interpretation of certain terms in the agreement and certain operational matters associated with Express Scripts' performance. While WellPoint is threatening to drag Express Scripts to court regarding the matter, Express Scripts is hopeful of a mutual settlement.
Management at Express Scripts stated that the contractual dispute is not expected to impact its financial position adversely. However, given the significance of the deal (highest contributing client, accounting for 29.5% of revenue in 2011), the present development is less than desired.
We believe that the termination of the WellPoint-Express Scripts agreement would weigh down the top line at Express Scripts. Additionally, Express Scripts might have to revise its guidance if the aforementioned dispute resolves on a sour note.