By Ilya Korzinkin | 13/02/2019
Overview of the deal
Acquirer: Cigna Corp.
Acquirer Advisors: Lazard, Centerview Partners LLC
Target: Express Scripts Holding Co.
Target Advisors: Morgan Stanley
Estimated transaction value: $67.8bn
Announcement date: March 2018
Reinforcing the trend for PBM and health insurance transactions set by the $70bn CVS Health Corp takeover of Aetna announced only a month prior, this acquisition officially ends the era of large, standalone US PBMs. The deal aims to consolidate the NewCo’s competitive position in the increasingly complex US healthcare landscape and ward off any potential rivals by using the combined platform to differentiate its service and product portfolios to accelerate growth.
Cigna Corporation has acquired all of Express Scripts’ equity in a combined cash and stock deal and has assumed Express’ Scripts’ $15bn of debt, bringing the total transaction value to ~$67bn, which represents a premium of around 30% to take control of Express Scripts’ shares. The acquisition consideration consists of $48.75 in cash and 0.2334 shares of NewCo’s stock per every Express Scripts share. Post acquisition, Cigna shareholders own 64%, and Express Scripts shareholders 36%, of the company. David Cordani serves as the President & CEO, whilst Tim Wentworth serves as President & CEO of the services sector, with the newly formed management of now 13 directors pledging to make an incremental investment of $200mm in Cigna’s charitable foundation.
Whilst management remains optimistic that the acquisition will pass lower costs down to consumers and provide a ‘more coordinated approach to an individual’s healthcare journey’ in tandem with creating long term value for shareholders, a substantial number of experts, clients and employees have a different view.
“Medicare Part D is a big deal for PBMs and the insurers, like Cigna, that have merged with them in recent years. This would be a serious disruption to the status quo. If the rule goes through as proposed, PBM leverage and negotiating power would likely be significantly weakened."
Company Details (Cigna Corporation)
Cigna Corporation is an American health services organisation, whose subsidiaries are major providers of medical, dental, disability, life and accident insurance. The company ranked 73rd in the 2018 Fortune 500 list of the largest United States corporations by total revenue.
- Incorporated in 1982, Headquartered in Bloomfield, Connecticut, US
- President and CEO: David Cordani
- Number of employees: 46,000
- Market Cap: $70.8bn - EV: $83.3bn
- LTM Revenue: $45.8bn - LTM EBITDA: $5.4bn
- LTM EV/Revenue: 1.8x - LTM EV/EBITDA: 15.4x
Company Details (Express Scripts)
Express Scripts provides integrated pharmacy benefit/claims management (PBM) services, benefit-design consultation; drug-utilization review; formulary management; and medical/drug data analysis services. The company is the 25th-largest in the United States by total revenue as well as the largest pharmacy benefit management organization in the United States.
- Founded in 1986, Headquartered in St. Louis County, Missouri, US
- President and CEO: Tim Wentworth
- Number of employees: 26,600
- Market Cap: $52bn - EV: $66bn
- LTM Revenue: $100bn - LTM EBITDA: $7.2bn
- LTM EV/Revenue: 0.14x - LTM EV/EBITDA: 1.94x
Projections and Assumptions
Short term consequences
Post transaction, the NewCo’s adjusted net debt has ballooned up to $36bn from $2.5bn FY 2018. This represents a debt to equity ratio (ex. Minority Interest) of 97.9%, which is predicted by management to go down to <57% by 2020 although analysts are suspicious of this claim because of the complexity of Express Scripts’ financing structure. The NewCo is predicted to achieve $152bn of revenue FY2019, with net profit double of that in 2018, however the EBITDA margin is expected to decrease from 11.8% FY2018 to 9.2% FY2019 and 8.7% FY2020, and net margin down from 7.7% to 4.2% from 2018 to 2019.
In the short term, it would be wise to consider the two businesses as one on paper, however each operating in their own respective areas until business integration is fully complete. Until then, if each firm continues to generate revenue at the same rate, and deal wisely with immediate Medicare (part D introduction) legislation changes, then the shareholders of Cigna-Express Scripts would be entitled to reap the benefit of confidence from of an increased top-line and promises of greater managerial economies of scale.
The question going forward into the medium term would primarily lie in how successful the NewCo’s management will be in integrating Express Scripts’ PBM service model into the insurance/healthcare packages they offer to their institutional clients, which seems to be the main revenue generator for Cigna. Moreover, it is uncertain what costs the transition from Cigna’s own PBM scheme, contracted out to rival UnitedHealth, will bring about, and how quickly it is completed.
Long term upsides
Vertical integration may enable better cost management throughout the organisation, bearing the classic cost cutting benefits such as integration of finance/marketing/operations divisions. Furthermore, the now integrated Cigna would have more access to data provided by Express Scripts on patients’ health outcomes, therefore being able to fine tune their insurance plans and projections as to which prescribed medications work, and which do not, resulting in the better quality of the overall product.
Much here hinges on the future of the PBM, and corporate insurance markets, both on the competition and legislation (Medicare D) front. The promise of lower costs to consumers resulting from greater integration may be only partly true. With standalone PBM’s mostly gone, and large PBM’s facing less financial risks through being a part of a larger and more diversified organisation, the market model that relied on independent PBM’s keeping drug prices constant due to competition is now outdated. Hence, there are no economic incentives for integrated PBM’s to reduce prices with no real competition, a benefit in the short term should prices rise, but in the long term a potential demand killer. Furthermore, such integration may enable greater customer negotiating power in corporate rebate contracts placing clients in a better position for contracts in which they bear risk for at least some portion of healthcare costs, for example, risk-sharing arrangements, whereas standalone, Express Scripts as a PBM would ordinarily face little to no risk in such contracts. Ultimately, it comes down to how viable PBM as a business model will be, if viable at all, in the healthcare industry of tomorrow, especially with Mr. Trump’s Medicare D changes coming into play, aiming to destroy rebates: the very reason why PBM’s exist.
Risks and Uncertainties
The main risk here is if the PBM industry will exist in the future as Medicare Part D changes come into play. Changes include outlawing the current system of drug price negotiation in some government programs, and stopping them in Medicare and Medicaid covered programs (covering up to 50 million Americans), and only allowing rebates that are fully passed on to consumers, which would prohibit deals between PBMs and drugmakers that are based on sales volume in favor of fixed-fee arrangement. If these changes are then fully passed on in the private sector, then Cigna has made a $70bn gamble for a virtually dying business. This was countered by Cigna officials on the February 1st conference call, who argued that these changes are not to majorly impact Express Scripts current business model. However, even in the short term, PBM negotiating power will be weakened significantly.
Apart from the legislature changes, there are still plenty of other risks to Express Scripts. For example, smaller insurers who contracted out their pharmacy benefits management to Express Scripts will most likely be terminating their contracts, as they would essentially be benefiting their competition by still doing business with the company. Clients who hired Express Scripts for their employees’ drug benefits while maintaining a separate insurer for health insurance coverage may now decide to end their relationships because of the Cigna connection. On the insurance front, Cigna could struggle to compete with new market entrants disrupting the healthcare provision market in the US, e.g. Amazon, Berkshire Hathaway, and JP Morgan Chase, announcing that they would form a joint venture to provide healthcare to their employees which could signal an end to traditional suppliers and insurers. If this consortium build momentum, traditional insurance providers may be forced to restructure their operations to face competitors that are not operating with a profit motive, requiring significant resources, which Cigna may not have trying to keep Express Scripts afloat. Taking this into account, only time would tell whether Cigna’s gamble could prove successful to any degree, however, the current market trends indicate it to be value destructive.
“In a nutshell, if the Cigna / Express Scripts merger goes through, Cigna is almost certainly destroying value in its purchase. If the deal falls through, Express Scripts is, in our opinion, a dead man walking."
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