McKesson in Three-Way Contest for $30 Billion VA Drug Contract

McKesson Corp. (MCK) is in a contest with Cardinal Health Inc. (CAH) and AmerisourceBergen Corp. (ABC) for a U.S. Department of Veterans Affairs drug distributor contract worth as much as $32 billion.

“It is really a horse race between all three,” said Charles Rhyee, a New York-based analyst with Cowen Group Inc. (COWN)

McKesson has been the sole medicine supplier for veterans’ hospitals and the department’s mail-order pharmacy since 2004. The new contract, which the VA plans to award by January, will determine whether the San Francisco company keeps all or part of the work, valued at about 2 percent to 4 percent of McKesson’s current earnings, according to Lisa Gill, a New York-based analyst with J.P. Morgan Securities LLC.

“McKesson has done a really good job -- they have high customer satisfaction, but it may not matter because if someone bids substantially below them they may lose the contract,” Gill said in a phone interview. “Price is by far the biggest determining factor.”

McKesson, the largest U.S. drug distributor based on revenue, won the contract from AmerisourceBergen on Dec. 31, 2003. Its bid gave the government a 5 percent discount from standard wholesale prices, then expanded the discount to 5.05 percent in July 2005 and 5.15 percent in October 2007, a company spokesman told Bloomberg Government last year.

Three companies are vying for a U.S. Department of Veterans Affairs drug distributor contract worth as much as $32 billion. Photo: AP GraphicsBank Close

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Three companies are vying for a U.S. Department of Veterans Affairs drug distributor contract worth as much as $32 billion. Photo: AP GraphicsBank

Prior Experience

“The VA is America’s largest integrated health system, and McKesson is proud to partner with them,” Kris Fortner, a McKesson spokesman, said in an e-mail. McKesson’s revenue for its most recent fiscal year, ending March 31, was $112.1 billion.

McKesson’s current contract had a two-year base period with three two-year renewal options. The previous contract, awarded to AmerisourceBergen in 1999, had a one-year base period with four one-year renewals.

“We have prior experience serving the VA, and we are confident that we could serve them well in the future,” Barbara Brungess, an AmerisourceBergen spokeswoman, said in an e-mail. The Valley Forge, Pennsylvania-based company had $80.2 billion in revenue during the 12 months ending Sept. 30.

AmerisourceBergen isn’t likely to have submitted an “irrational” low bid to win the contract, Gill said.

Cardinal’s Bid

“I’m sure they really do want it back,” Gill said. “It’s a good contract, there’s a lot of revenue but I don’t think they have the kind of management team that will try to win it at any price.”

Cardinal Health, the second-largest U.S. drug distributor by revenue, is also competing for the work, “as is our practice when significant business is put out for bid,” Deb Mitchell, a Cardinal spokeswoman, said in an e-mail. The company’s revenue was $102.6 billion during its most recent fiscal year, which ended June 30.

The Dublin, Ohio-based company shouldn’t be counted out, said Rhyee, the Cowen Group analyst. “Cardinal is more than capable of handling this contract,” Rhyee said.

News that AmerisourceBergen had lost the contract in 2003 surprised analysts and company officials, said Thomas Gallucci, an analyst with Lazard Capital Markets Ltd. in New York.

“It was a debacle, none of the companies knew what was going on,” Gallucci said in an interview. “And it happened on New Year’s Eve.”

Impact on Stock

McKesson shares increased 3.4 percent on Dec. 31, 2003, while AmerisourceBergen’s dropped 12 percent.

By mid-June 2004, McKesson’s stock was up more than 15 percent. There was some delay in the stock’s reaction to the contract because McKesson didn’t update earnings guidance for several months and AmerisourceBergen had filed a lawsuit over the award, Gill said.

The upcoming award, which may be worth $4 billion a year in revenue, isn’t likely to make or break any company or dramatically shift the market since all three distributors have annual revenue of between $80 and $120 billion, Gallucci said.

“This is a significant contract, but not a game-changer,” Gallucci said. “Does it make one company big and one company small? No.”

While McKesson was once seen as likely to win the new contract because of its incumbent status, “the tone is changing a little bit,” Gill said.

“What’s happening on the street is they’re trying to read the tea leaves, they’re studying the body language of management,” she said. “And McKesson says we don’t know, we have no idea what’s going to happen.”

To contact the reporter on this story: Kathleen Miller in Washington at Kmiller01@bloomberg.net

To contact the editor responsible for this story: Jon Morgan at Jmorgan97@bloomberg.net

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