1. Medco Health Solutions, Inc.
Yuqian (Annie) Zhang
Piotr Chorzewski
Nov. 18th, 2004
07/11/2018

2. Basic Facts Split from Merck in August 2002
Share Price on August 21st $25.57
36 shares x $38.76=$1, on Nov. 16th 2004
Gain 51.58%
P/E: 22.81
EPS: 1.7
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3. Prescription Benefit Management Customers base Competitive environment
Industry
Prescription Benefit Management
Customers base
Competitive environment
Business model
Industry controversy & litigations
Prescription Benefit Management – the main goal is to help control drug expanses of its clients.
To deliver Drugs to customers of its customers for a low price.
Customers
Blue Cross/Blue Shield plans; managed care organizations; insurance carriers; third-party benefit plan administrators; employers; federal, state and local government agencies, and union-sponsored benefit plans.
One can’t say that it is highly competitive environment in which Medco operates.
There are three main players
Medco Health Solutions
Experess Script
Caremark
There are also smaller Internet Pharmacies. However Medco is strong in this market segment. Medco claims to developed the nation’s largest Internet pharmacy.
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4. Stock performance
07/11/2018

5. Profitability PBM Revenue Medco Caremark Express Script Retail Revenue
22,661.1
4,522.1
9,037.25
Mail Revenue
11,252
4,487.8
3,988.14
Services Revenue
351.4
57.4
72.9
Total
34,264.5
9,067.3
13,089.26
Gross Margin
4.4%
8.47%
4.7%
Operating Profit Margin
2.41%
5.85%
3.38%
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6. Basic financial comparison - EPS
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7. Basic comparison – Gross Margin
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8. Basic comparison – Operating Margin
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9. SWOT Analysis Strength
Top one in terms of absolute volume of mail orders
More than total of three largest competitors in 2003
Mail order service typically reduces prescription drug costs by 8-10 percent
Weakness
Overall low growth with huge contract losses
Sales growth
Caremark 33% 21%
Express Script 8% 42%
Medco 4% %
Low profit margin
Impact from Merck
Strength:
Mail order service typically reduces prescription drug costs by 8-10 percent.
Medco mail orders growth: % , 2002 – % , in 2003, took 33% of total revenue
Caremark mail orders growth: 2003 – % , %, in 2003, took 49% of total revenue
Express Script mail orders growth: %, %, in 2003, took 30% of total PBM revenue
Mail penetration in Q3 2004
Caremark 20.9%, Express Script 23.3%, Medco; 40.1%
Weakness:
In mid-2004, contract losses exceed $2B including big clients such as Independence Blue Cross, Texas Retirement, and state of Ohio. Starting from Q1,05, loses its largest mail customer Federal Employees. Although the company announced new business 1.2B for 2005, the net result is still negative.
07/11/2018

10. SWOT Analysis Opportunities Threat Aging population
Growing demand for generic and mail pharmacy
Threat
Competition from other PBM companies and retail pharmacies
Increasing prescription drug cost
Ongoing government probe of the company as well as the other PBMs
Opportunities:
Medco proactively educates physicians and patients about generic drugs as quality, low cost alternatives. Generics First program facilitates the switch from brand name drugs to genetic ones. High volume of purchase directly from drug manufacturers enables Medco to sell generic drugs at substantially lower prices for customers while increasing its margin.
Threats:
MHS has lost retail business to competitors, although mail orders keep growing, the overall growth is slow.
Medco took a hit Tuesday over concerns that problems in the broader insurance sector -- which is targeted by New York Attorney General Eliot Spitzer for alleged bid-rigging -- could prove contagious. Most analysts downplayed the exposure for health benefit companies, especially PBMs
PBMs have increasingly become targets of government investigators who suspect them of unfairly profiting at their customers' expense,
Medco: government settlement that could reach as high as $1 billion
PBMs originally relied on processing fees from their customers to generate profits. But over the years, she said, PBMs have come to depend on suppliers -- who offer rebates and other incentives -- for most of their earnings. Because PBMs often conceal these sums as competitive information, she said, their customers have been unable to nail down the reasons for their climbing drug costs.
“PBMs have been the source of significant scrutiny over the years by a variety of sources," wrote Merrill Lynch analyst Thomas Gallucci. And "while such scrutiny has created share-price volatility in the past, the industry's business practices have not been materially impacted as a result of these examinations so far."
The government has accused Medco of defrauding government customers in multiple ways.
Consumers care price and quality, while it is hard for PBM to differentiate themselves in terms of service quality in this industry, lower price is the only way, while with the increasing drug cost, already low margin, volume is key point. Whoever achieve the higher volume growth will win in the long term, consolidation will be favourable to increase market share.
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11. Valuation-DCF Discount rate 8.9 9.8 10.7
Sales in $M Growth rate
EBIT in $M EBIT margin
Free cash flow
Discount rate
Target price(constant growth)
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12. Valuation-Multiples Projected EPS P/E=14 P/E=18 P/E=22 P/E=26
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13. Sensitivity analysis
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14. Recommendation-sell Sell 36 shares of Medco at the market
Contingency plan if any interests in the industry
Monitor the progress of the legal issues in the industry in the near future
Perform valuation of other PBMs such as Caremark if do have confidence in the industry
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