As many of their customers brace for changes under ObamaCare,
U.S. drug wholesalers are in expansion mode -- heading overseas
and forming purchasing co-ops wherever they see fit.
This massive piece of the healthcare puzzle is home to three
huge competitors. Two of those,McKesson (
), the largest, and No. 3AmerisourceBergen (
), are expanding heavily into Europe -- mainly through joint
The No. 2 player,Cardinal Health (
), has also been looking for new business outside the U.S.,
especially in China. But on Dec. 10 it announced a partnership
withCVS Caremark (
) to form what it claims will be the largest drug-buying venture
of its kind in the U.S.
Combined, the three top drug wholesalers handle more than 80%
of all drugs distributed in the U.S. They provide drugs to retail
pharmacy chains, independent pharmacies, hospitals and nursing
"Distributors are the most diverse players in the health-care
supply chain," said analyst Eric Coldwell of Robert W. Baird
& Co. "They are not reliant on specific product classes or
devices. They sell across the board."
Boots, Celesio And CVS
All three top drug distributors saw shares prices soar more
than 60% so far in 2013. The gains hoisted the medical-wholesale
drug supply group to a top 20 ranking among IBD's 197 industry
AmerisourceBergen was the first to deal in Europe. In March,
it joined a partnership forged last year betweenWalgreen (
) and Alliance Boots, the Swiss firm that runs Boots, an
international pharmacy chain. Not only did AmerisourceBergen get
the nod to distribute pharmaceutical products to more than 8,000
Walgreen stores, it can buy generic drugs through a
Walgreen-Alliance Boots global sourcing joint venture.
McKesson is following AmerisourceBergen into Europe with its
planned $8.3 billion acquisition of German drug wholesaler
Celesio, announced in late October. Total revenue for the
combined company is expected to be more than $150 billion, up
from $122 billion in the fiscal year ending in March. It'll add
an estimated $1 to $1.20 a share to McKesson's earnings in the
Celesio sells drugs to customers in 13 European countries and
Brazil. Plus, it runs 2,200 pharmacies in six European countries,
including the U.K., where its Lloyds pharmacy chain is second
only to Boots.
McKesson expects to gain full control of Celesio in the fiscal
year starting in April. The plan has met some resistance from New
York-based hedge fund Elliott Management, which claims McKesson's
offer -- at around $31.55 a share -- substantially undervalues
Celesio. The fund owns 25% of Stuttgart-based Celesio.
In terms of big deals, Cardinal is no longer the odd man out.
In the agreement announced this month, Cardinal and CVS Caremark
will form a generic-drug buying operation in the U.S., to begin
in July, using their combined clout to score better pricing.
The venture will source and negotiate generic supply contracts
for both Cardinal and CVS. ISI analyst Ross Muken estimates their
combined generic purchasing comes to about $12 billion-$14
billion a year.
He figures Cardinal alone will save $235 million-$275 million
a year, adding 25-35 cents to its earnings once the combined
operation is fully up to speed.
Brands Vs. Generics
Wholesalers generate more revenue from selling brand-name
drugs than generics. But generics are more profitable. "With more
purchasing volume, they can extract additional discounts from
generic suppliers," said Adam Fein, president of Pembroke
Pharmacies typically buy brand-name drugs from wholesalers.
Smaller pharmacies also tend to buy their generic drugs from
wholesalers. But larger pharmacies usually buy generic drugs
directly from manufacturers. That's why small, independent
pharmacies have traditionally been drug wholesalers' life
AmerisourceBergen's new ties with Walgreen and Alliance Boots,
and now Cardinal's with CVS change that dynamic.
"It's a big deal for AmerisourceBergen," said Fein. He says
Walgreen will contribute almost $28 billion to
AmerisourceBergen's revenue in fiscal 2014.
The Cardinal and CVS buying group also is viewed positively.
Muken calls it "an unmitigated positive" for Cardinal, a move
that put the company back "on equal footing" with its two
In the drug wholesaling business, revenue is not the main
measure of success. Profits are, especially operating
Coldwell expects AmerisourceBergen to show near-term EPS
dilution and margin erosion from the Walgreen deal and from its
recent contract win with pharmacy-benefits managerExpress Scripts
(ESRX), the latter of which he calls "exceptionally
Cardinal's loss of both customers this year led to a $3.7
billion downshift in revenue. But shedding the tight-margin
agreements helped expand its gross margin to more than 5% in the
last quarter, Coldwell noted.
Cardinal still distributes branded drugs and some back-up
generics to CVS retail stores. CVS mostly self-distributes
ObamaCare, Generic Tail Winds
Wholesalers buy drugs from most manufacturers. The more
customers they amass, the better they are able to leverage
discounts. Analysts see ObamaCare feeding the industry's leverage
as more uninsured patients gain insurance coverage and access to
New health insurance enrollees from ObamaCare could add up to
1% incremental revenue growth for drug wholesalers next year and
another 3% or more in 2015, Coldwell says.
Yet, as wholesalers, drug distributors dodge the reimbursement
dynamics their customers face, where revenue and profit are
sensitive to changes in health plans, budgets and health-care
reform, Coldwell says.
And unlike drug, biotech or medical-device firms, distributors
aren't as dependent on a small number of products.
The flow of new generic drugs slowed this year following a
huge wave that peaked in 2011 and 2012. "Another wave of generics
is coming," said Coldwell. "We've started to see a modest
recovery in generic launches and that will continue to build over
the next 12 months," he said.
Brand-name drugs with sales of $73 billion will lose patent
protection between 2013 and 2016, says Fein, who adds it's the
last phase of the generic wave that started building five to 10
years ago, as brand-name drugs lost protection.
Among the many brand names going off patent next year are the
MS drug Copaxone, acid-reflex drug Nexium and sleep aid
Inflation Plus Purchasing Power
Then there's the specialty-drug revolution that will keep drug
distributors busy and profitable, analysts say. The drug industry
is shifting from traditional, pill-based medicines for large
patient populations to high-priced specialty therapies targeted
to rare diseases and small patient populations.
"Wholesalers are a key part of the channel for specialty drugs
administered by hospitals and outpatient departments and they
have also started new specialty distribution businesses that
target physician offices and clinics," Fein said.
The drugs, usually biologic in origin, often need special
handling. This means higher profit margins for wholesalers
dealing with them.
Mergers and acquisitions will also keep fueling wholesalers'
growth, analysts say, along the lines of McKesson's $2 billion
buy of PSS World Medical and Cardinal's $2 billion takeover of
home-care products distributor AssuraMed earlier this year.
Cardinal has completed a number of small to midsize
acquisitions of U.S. distributors, and has followed a similar
course in China. Cardinal's China revenue jumped 29% in the last
quarter over the earlier year, but Deutsche Bank analysts
estimate that it accounts for just 2% of total revenue.
Analysts were not surprised by the latest deal from Cardinal
and CVS. Prior to the announcement, Deutsche Bank analysts
estimated that the McKesson-Celesio combination would give
McKesson twice the generic purchasing volume of Cardinal while
the AmerisourceBergen and Walgreen-Alliance Boots partnership has
two-and-a-half times the purchasing volume.
Meanwhile, generic drugs are fetching slightly higher prices
vs. the previous deflationary pricing environment. But even with
deflation, distributors are able to wrangle profits through
negotiations with manufacturers.
"Now they have negotiation power plus inflation," Coldwell
said, adding that generic prices are up in the low single digits.
"We think (price inflation) will be viable well into 2014 if not