“You are going to want to watch it Walgreen’s and CVS, finally coming together on an agreement on the pharmacy benefits network.” – Bloomberg TV’s In the Loop 6/18/2010
Two of the fiercest competitors in the have ended a short lived yet very public spat over participation in CVS’s (CVS) Pharmacy Benefits Management Program. Just over a week ago, Walgreen (WAG) announced that it would not participate in any new or renewed prescription drug plans awarded after June 7th, as it was not happy with the way the partnership had gone. Primary among WAG’s concerns was a lack of transparency into how the prescription drug plans were administered, which “made it unacceptably difficult for Walgreens to reasonably and economically plan for and operate its business.” The press release went on to say, they felt that they were “no longer viewed as a valued community pharmacy within its PBM network.” Two days later, CVS said they had “no choice” but to terminate Walgreen’s participation within 30 days as negotiations have grinded to a halt. The PHB includes some 64,000 pharmacies, but Walgreens represents a large portion of that network with 7,000 locations participating.
Since that time, both stocks have been hammered down more than 10% coming into today as the PBM partnership is an important source of revenue for each of these companies (reimbursement from CVS Caremark represented 7% of Walgreen’s revenue). The market’s disapproval of the ugly breakup has apparently brought both sides back to the table, and it was announced this morning that they have ironed out their differences and the program will continue with new unreleased terms. Wall Street analysts agreed that the break-up would have undoubtedly hurt both companies, but opinions differ on which one would have been hardest hit. The only analyst that truly matters, Mr. Market, had docked both stocks nearly equally as Walgreen’s and CVS were down 9.7% and 9.6%, respectively since the first signs of trouble.
While terms were not released, we think it is likely that Walgreen’s was able to coax out more amenable terms from the new contract, but of course that is speculation until terms are defined. Walgreen’s was showing strong growth in the program, and it truly was to both company’s benefit to refresh the deal. Accordingly, both Walgreen and CVS Caremark are trading higher this morning both by more than 3% on very heavy volume as of the time of writing. At Ockham, we have had an Undervalued rating on both CVS and Walgreen since before the spat intensified, and we will only reaffirm that rating now. According to our methodology, Walgreens is the more attractive of the two, but the difference in valuation is fairly small. It appears this important source of revenue for both firms has been secured for the foreseeable future, and that is in the best interests of CVS, WAG and investors. Competitors Express Scripts (ESRX) and Medco Health Solutions (MHS) are trading slightly lower on the news, as they were expected to gain market share as a result of the disruption.