Health

Max Nisen is a Bloomberg Gadfly columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

In losing Anthem Inc. as a client, Express Scripts Holding Co. is surrendering more than just its biggest customer and 18 percent of its revenue. Its very identity is now at risk. 

The PBM on Monday night said it expected to lose Anthem's business at the end of 2019 after a long, bitter pricing dispute. Through Monday's trading, Express Scripts shares had fallen more than 20 percent since the Anthem squabble began in December 2015 -- so this news was somewhat priced into the stock. 

But shares fell another 10 percent Tuesday morning, partly because Anthem's departure casts doubt on Express Scripts' ability to rule its sector as the last big pure-play PBM.

Loss
Fears about losing Anthem's business, and their fulfillment Monday, have weighed on Express Scripts shares
Source: Bloomberg

Anthem is a significant contributor to Express Scripts' earnings, accounting for about 31 percent of adjusted Ebitda in 2016, according to data the company broke out for the first time on Monday. That's substantially higher than analysts had believed. Anthem's relative contribution to earnings has grown over the past two years, and Express Scripts expects it will keep growing.

Anthem will be difficult to replace. The only insurer larger than it, UnitedHealth Group Inc., runs its own PBM. So does Humana Inc. Cigna Corp. signed a 10-year contract with Catamaran -- since acquired by UnitedHealth -- in 2013 and handles a lot of its PBM services in-house.

One possible target, Aetna Inc., is under contract with CVS Health Corp., a deal that conveniently expires in 2019. But Aetna recently tried to get back into the PBM business with its failed acquisition of Humana, and it may still be looking for other avenues.

Haircut
Anthem represents a large and increasing portion of Express Scripts' earnings, and it's on its way out
Source: Express Scripts
*related to the acquisitions of Coventry and Catamaran

Express Scripts expects compounded annual Ebitda growth of two to four percent through 2020,  excluding Anthem and other transitioning clients.  That's a risky projection to make, considering others might follow Anthem out the door, assuming it knows something they don't about Express Scripts and the pricing environment.

The risk of further client flight may be ameliorated somewhat by the fact that Anthem had an odd contract with unusual pricing terms, created back in 2009 when Express Scripts acquired its PBM. 

Express Scripts said on its Tuesday morning earnings call it made substantial concessions trying to keep Anthem, to no avail. It's possible Anthem's demands were so unreasonable, as Express Scripts claimed, or that relations had gotten so bad, that a split was inevitable. 

But it's also possible Express Scripts isn't set up to give Anthem what it wants, in terms of pricing, transparency, or services. Anthem's departure suggests someone is offering more savings than the $3 billion in additional discounts Express Scripts said it offered.

If Anthem were to turn to CVS Health in 2019, then that would validate CVS's broader business model -- with a much larger pharmacy and dispensing presence -- and ability to offer competitive pricing. An Anthem contract would also make CVS the largest PBM, supplanting Express Scripts.

If Anthem goes to a lower-cost, smaller firm, such as Prime Therapeutics, then it will be seen as a signal that Express Scripts is too costly and that its margins may be unsustainable, already a worry in the current drug-pricing environment. A newer class of "transparent" PBMs charge a flat fee for processing prescriptions, rather than the more-complicated pricing Express Scripts employs.

And if Anthem decides to go with an in-house PBM, then it will create a new competitor and continue a trend among insurers and employers toward managing larger portions of their own drug benefit rather than outsourcing it. 

Today's selloff isn't just about Anthem's departure, it's about the rising possibility Express Scripts will shrink from being the dominant player in a promising industry to just another competitor in an increasingly difficult environment. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Max Nisen in New York at mnisen@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net