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View: Don't judge Express Scripts only by its Anthem fight

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(Bloomberg) — The high road has its uses beyond creating a warm cocoon of smugness.

On a call with analysts Wednesday discussing its fourth quarter earnings, pharmacy benefit manager Express Scripts (Nasdaq:ESRX) declined to offer much in the way of details about its contentious price negotiations with health insurer Anthem (NYSE:ANTM), its biggest client, citing a policy of keeping such discussions private. In doing so, the company managed both to keep its cards close to its chest and sneak in some jabs at Anthem’s choice to take things public. 

Anthem claims Express Scripts owes it $3 billion a year in extra prescription drug savings under a 10-year contract that runs through 2019. Express Scripts begs to differ. “I have no clue where the $3 billion came from. I have no concept; the number doesn’t make any sense to me,” CEO George Paz said on the call.

See also: Anthem not entitled to $3 billion, Express Scripts says of talks

The possibility that Express Scripts could either lose Anthem as a customer or be forced to slash prices has driven its shares down 20 percent since negotiations became public. Such uncertainty will likely weigh on the stock for a while, as both companies are holding their ground. But there’s still plenty of upside for investors in Express Scripts.

PBMs lower drug costs — and pad their profits — by pushing patients into generics and by negotiating with drugmakers for lower prices on expensive branded drugs. More than 84 percent of prescriptions filled by Express Scripts in the fourth quarter were generic, up from less than 75 percent in 2011.

Prescriptions keep getting more profitable for Express Scripts. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) per claim hit $5.66 in the fourth quarter, up 2.7 percent from the same period in 2014 and up more than $1 from 2013. That reflects both higher generic usage and the company’s skill at squeezing discounts from drugmakers, through aggressive negotiations and the use of its formulary, or preferred-drugs list.

The best example of this is Express Scripts’ deal to cover an AbbVie hepatitis C (HCV) drug and exclude Gilead’s competing, more-expensive HCV drugs. This arrangement has saved clients more than $1 billion dollars, Express Scripts claims. Those prescriptions were all routed through Express Scripts’ growing specialty pharmacy, Accredo, making it extra money.

The company plans a similar approach to a pricey new generation of cholesterol drugs and is working to tie cancer drug prices more closely to how well they work in different types of disease.

One thing that makes Express Scripts so effective in negotiations is its size. Acquiring Medco in 2012 helped turn it into the biggest PBM in the U.S. It processed 1.29 billion adjusted claims last year, compared to 751 million four years ago. Serving more patients means it can extract bigger discounts, which in turn attracts more clients. Losing Anthem, which makes up an estimated 14 percent of Express Scripts’ revenue (though less of its profit), would be a blow in 2019. But the company would still likely manage more than a billion claims a year, leaving it plenty big enough to warrant preferential treatment from drugmakers.

The company is looking at M&A opportunities, as well, which might restore or add to its scale and capabilities.

There’s a chance that both the Anthem-Cigna and Aetna-Humana mergers go through, and that both merged companies emulate UnitedHealth (NYSE:UNH) by abandoning independent PBMs and managing prescriptions themselves. Drugmakers are apparently excited about the prospect of negotiating with a more fragmented PBM market. But even that worst-case scenario might not fundamentally alter the dynamic between big pharma and PBMs, according to Bloomberg Intelligence analyst Jonathan Palmer. The only truly major shifts in such a scenario would be Anthem ditching Express Scripts — already a risk — and Aetna (NYSE:AET) ditching its current PBM of choice, CVS. Humana (NYSE:HUM) already runs its own PBM, and Cigna (NYSE:CI) already manages many of its drug benefits internally. The biggest PBMs wouldn’t lose much negotiating power.

Even the fight with Anthem could end up being less awful than investors expect. The companies’ $3 billion gap is just a starting point of negotiations, not the end. And the date of Anthem’s potential departure in 2019 is still a good ways off; the likelihood of it leaving any sooner is low and legally problematic.

Neither Anthem nor Express Scripts will likely get everything it wants in negotiations. But Express Scripts is priced for total disaster. If anything less than that happens, then investors might remember why they liked the company in the first place.  

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