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MedcoHealth SolutionsMHS (NYSE)
Keith FendersonAinsley Woolridge
Mike Mathis
The Nittany Lion Fund, LLC.
Penn State Investment AssociationHealthcare
MHS expected to report Nov 1
Team Recommendation: Bench
Introduction
Description
Key Drivers Valuation Conclusio
n
•Drug Trends
1
•Retaining and Growing Value
2
•Supplementing Core Op’s
3
•12 Month Price Target:
$72
•Appropriate Entry Price:
< $57
Top Three Reasons to Purchase:
Company Description► Medco is a pharmacy benefits manager
(PBM), which acts as the middle man between drug companies and pharmacies. PBM’s use their size and scale to purchase drugs at discounts, and then provide the drugs along with proprietary services to client pharmacies. Members fill their prescriptions through a network of 60,000 pharmacies, a mail-order program, or the company's call-center and Internet pharmacies. In addition, Medco is the largest provider of specialty drug and pharmacy services in the rapidly growing US market under their Accredo brand. They dispense specialty drugs for rare/severe chronic illness, usually injectable or infusion drugs, to patients with serious diseases, e.g. cancer and hemophilia. Medco manages drug benefits for clients that include unions, corporations, HMOs, and federal employees
Introduction
Description
Key Drivers Valuation Conclusio
n
Revenue Breakdown
Introduction
Description
Key Drivers Valuation Conclusio
n
100% US RevenueInternational EPS
contribution likely to begin in 2015
International Expansion into key European markets
Tremendous amount of interest in Medco software and services from European Government-run HC 83%
17%
Revenue BreakdownPBM Specialty Pharmacy
Competitive Landscape
Introduction
Description
Key Drivers Valuation Conclusio
n
► Express Scripts (ESRX)► PBM services include retail network pharmacy
management and retail drug card programs; home delivery pharmacy services; specialty pharmacy services; patient care contact centers; benefit plan design and consultation serving HMOs, health insurers, third-party administrators, employers
► CVS Caremark (CVS)► Pharmacy services operating in two segments,
Pharmacy Services and Retail Pharmacy. The Pharmacy Service segment provides a range of prescription benefit management services, including mail order pharmacy services
► Catalyst Health Solutions (CHSI)
► Small cap PBM that provides its clients access to a contracted national network of approximately 63,000 pharmacies
Drug Trends► Medco is set to capitalize on the $80-90 billion generic wave over next five years, with
2011 being the weakest contributor through 2020► $29 billion of drugs coming off patent in 2012 estimated $.60-$.65 EPS
contribution in the year alone► Medco makes 5-10x more profit on generic drugs
► Currently 5/10 top grossing drugs are biologics, and by 2016 that will increase to 9/10► Pending formal FDA approval process for biosimilars (generic biotech)► 46 biotech products ($42.3bb) coming off patent through 2020► Over 611 specialty compounds currently in phase II, III testing► 2010 prescription volumes up 6.5% to a record 957 million prescriptions, generic
dispensing rate rose 3.5 to 71%► 2010 Mail-order generic dispensing rate up 3.7 to a record 61.5%
Introduction
Description
Key Drivers Valuation Conclusio
n
Drug Trends
Introduction
Description
Key Drivers Valuation Conclusio
n
Retaining & Growing Value► Highest client retention rate among competitors at >99%
► ~95% for ESRX, ~97-98% for CVS► $5.3 billion in net new sales in 2010, $1.5 net new sales at
year end for 2011► Incredibly high barriers to entry in PBM industry due to
scale, pricing power, high desired service level in long term customer relationships
► Earnings growth from demographic, legislative, and generic shifts will be significantly compounded by mail order service and utilization
► Worlds largest mail order pharmacy allows members to order longer three month prescriptions which results in substantially higher margins and higher adherence
► Entrance into online OTC drug market► First and only Prescription Drug Provider to ever win 5
stars from Governmental Center for Medicare/Medicaid Services’
► Medco Topped Industry on Fortune's List of 'World's Most Admired Companies' for Fourth Consecutive Year in 2011Introducti
onDescriptio
nKey
Drivers Valuation Conclusion
Supplementing Core Op’s
► Medco is the nation’s leader in specialty pharmacy care through its subsidiary Accredo Directly tied to growth in biologics
► Focuses on specialty medicines expensive and difficult to administer, that are used to treat chronic and life-threatening diseases
► Specialty pharma to be a significant driver of growth/ margin expansion
► 17% of sales in 2010, 30% of sales in 2015► Clients look for a full value proposition when choosing benefits
manager► Unparalleled proprietary services combined with bolt-on
acquisitions► United BioSource acquisition “makes medicine smarter”
by promoting medical treatment based on research evidence
► Post-approval testing (Phase IV) for safety, economic cost-benefit evaluation, and outcomes research
► UBC anticipates sales will have an annual growth rate of 20%
► “With its global presence and emphasis on post-approval drug research that is designed to guide the safest and most efficient use of the most effective medicines, this acquisition is perfectly aligned with our broader strategy to ‘make medicine smarter,’”
David B. Snow Jr., Medco Chairman and CEO
Introduction
Description
Key Drivers Valuation Conclusio
n
Supplementing Core Op’s
► Medco Research Institute ► Closes the gap between scientific discovery and medical
practice in order to make healthcare more precise► The Center for Therapeutic Resource - pharmacy specialists
driving adherence► Poor drug adherence and mismanagement account for
>$350b in waste/ yr► Omission gaps are not uncommon, TRC monitors
prescription drug use in patients with chronic conditions and aims to close these gaps
► Personalized medicine and genetic testing represents $10-15 billion market
► Medco has positioned itself for market leading genomic research through its acquisition of DNA Direct
► Pharmacogenetics improve care and lower overall healthcare costs
► Creates less waste, greater dosing precision, reduced risk of adverse affects and higher probability of a successful therapy
► Genomic services gaining traction in the market place; 9 out of 10 doctors want to integrate genetic testing will be the future way of care
Introduction
Description
Key Drivers Valuation Conclusio
n
Comparable Analysis
Introduction
Description
Key Drivers Valuation Conclusio
n
Comparable Analysis
Introduction
Description
Key Drivers Valuation Conclusio
n
Five Year Summary
Introduction
Description
Key Drivers Valuation Conclusio
n
Projections
Introduction
Description
Key Drivers Valuation Conclusio
n
Growth Analysis & CAGRS
Introduction
Description
Key Drivers Valuation Conclusio
n
Discounted Cash Flow
Introduction
Description
Key Drivers Valuation Conclusio
n
One Year Stock Chart
Introduction
Description
Key Drivers Valuation Conclusio
n
3/18/11: Medco was sued by a member of CalPERS’ health plan alleging that CalPERS members had
been paying too much for medications
7/22/10: Medco earnings missed
analyst expectations by
$0.02
8/16/10: Medco announced the
purchase of United BioSource for
$730MM
11/2/10: Medco beat earnings and raised its full-year earnings estimate
Company and Sector Risk► CalPERS contract loss due to controversy
over $4mm paid to board member for “consulting fees” who was then retained as a consultant
► Medco likely not the target of federal investigations
► Two large clients up for renewal: Federal Employee Program & UNH
► Negotiations will begin with UNH this summer
► FEP will likely decide renewal in May► Weaker than expected new business wins or
client retention► Competitive pressure on profitability metrics
► Competitors desperate to win contracts may bid irrational pricing
► Difficulties surrounding the integration of recent acquisitions (e.g. UBC)
► A potential slowdown in prescription drug utilization growth
19
Risk Analysis
Benchmark Risk
Sub-Sector
Geographic
Valuation
Market Cap
Company Specific
Valuation
Earnings
Volatility (Beta)
Acquisitions
Momentum
Industry Specific
Regulation
Relative Service Level
Contracts
0 1 2 3 4 5
0 1 2 3 4 5 Notes
12.9x forward pe to 19.3x industry avg
Integration critical
No fees, taxes, would benefit from overhaul
Debt & Correlation
Introduction
Description
Key Drivers Valuation Conclusio
n
Questions or Comments?
MHS expected to report Nov 1
Sector Strategy
Introduction
Description
Key Drivers Valuation Conclusio
n
Our services exposure, Wellpoint, has run up ~21% nominally YTD, while many fundamental issues and risks remain in the managed care industry Potential for more adverse legislation traded down on
Obama’s budget plan Historically HMO’s have traded at 13-18x, currently at 10x
While we still think that there is more room for multiple expansion, we feel that we need to be prepared to make a move after earnings season
We would wait until after Medco reports April 28th, and then look for further clarity on FEP contract and CalPERS
JP Morgan Report Highlights
Introduction
Description
Key Drivers Valuation Conclusio
n
Lisa Gill ranked #1 Healthcare analyst Most bullish on PBM’s for 2011 and Medco specifically (OW $78 PT)
CalPERS Believes CalPERS has a marginal impact– itself was only $500mm sales Only issue might be with Government contracts, and harder sell for new
clients Federal Employee Program- FEP (renewal decision expected in may)
FEP mail order contract .22-.31 in EPS *Medco mail order business is twice as big as ESRX and CVS, more
service offerings United Health Group contract (End in 2012)
Potential for UNH to internalize contract over 2013-2015- Expectation priced in
$.24-$.27 of 2010 EPS (6-8%) Worst case- $.60 overall potential impact of CalPERS, United, FEP,
and some key renewals See last slide
Most clients have long standing relationships with Medco. Members are more concerned with service level. Already Medco reps have reached out to clients to explain issue aside
Appendix
Introduction
Description
Key Drivers Valuation Conclusio
n
Valuation Summary5 Year Rel to
Current High Low AvgIndustry
P/ E (LTM) 17.6x 37.3x 16.2x 26.0x 0.8x
P/ E (NTM) 12.9x 23.5x 11.6x 17.9x 0.8x
PEG (NTM) 0.7x 1.3x 0.7x 1.1x --
P/ CF 10.2x 40.3x 7.3x 16.2x 0.8x
P/ Sales 0.3x 0.6x 0.3x 0.5x 0.4x
EV/ EBITDA 8.9x 15.7x 7.7x 11.8x 0.8x
5 Yr FCF CAGR 18.2%
Profitability 31-Dec-10 31-Dec-09 31-Dec-08 31-Dec-07
Return on Assets 8.2% 7.3% 6.6% 6.0%
Return on Equity 27.5% 20.7% 17.2% 12.7%
Return on Avg. Total Capital 14.7% 12.2% 10.5% 9.5%
Return on Avg. Invested Capital 14.7% 12.6% 11.2% 10.0%Efficiency
Inventory Turnover 53.9x 35.7x 25.1x 23.1x
Days of Inventory on Hand (DIO) 6.8 Days 10.2 Days 14.5 Days 15.8 Days
Total Asset Turnover 3.9x 3.3x 3.0x 2.7x
Appendix (Cont.)
Introduction
Description
Key Drivers Valuation Conclusio
n
Currently trading at 12.9x 2011E EPS versus 18.5 historical forward EPS
EPSLOSS 2012 EPS 15x 16x 17x 18x 19x
0.0 $4.97 $74.54 $79.50 $84.47 $89.44 $94.410.1 $4.87 $73.04 $77.90 $82.77 $87.64 $92.510.2 $4.77 $71.54 $76.30 $81.07 $85.84 $90.610.3 $4.67 $70.04 $74.70 $79.37 $84.04 $88.710.4 $4.57 $68.54 $73.10 $77.67 $82.24 $86.810.5 $4.47 $67.04 $71.50 $75.97 $80.44 $84.910.6 $4.37 $65.54 $69.90 $74.27 $78.64 $83.010.7 $4.27 $64.04 $68.30 $72.57 $76.84 $81.110.8 $4.17 $62.54 $66.70 $70.87 $75.04 $79.21
Forward PE
2011 Implied Value
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