By Jessica Wohl and Phil Wahba
CHICAGO/NEW YORK (Reuters) - Drugstore leader Walgreen Co may need to make amends in its $5 billion contract spat with Express Scripts now that the pharmacy benefits manager looks to be getting much bigger, industry watchers say.
Express Scripts Inc said on Thursday it would pay $29.1 billion to buy rival Medco Health Solutions Inc and become the biggest U.S. pharmacy benefits company, with easily one-third of the market.
The deal could take a year or more to pass through regulatory hurdles, but in the interim it could already have the power to realign the industry, from rival PBM companies to drugstores and pharmaceutical companies.
The Walgreen fight may be the most immediate example. Last month it said it was breaking its relationship with Express Scripts over prescription pricing, risking more than $5 billion in annual sales. But it would not be able to afford to shut out a combined company with Medco.
"It would give Express Scripts a bargaining position with Walgreen that would be somewhat crippling," said Bill Smead, portfolio manager of the Smead Value Fund.
Pharmacy benefit managers, or PBMs, administer drug benefits for employers and health plans. Express Scripts would gain even more leverage for negotiating drug prices if the deal went through.
Shares of Walgreen, which had no comment on the impact of the deal, fell 5.3 percent to $39.58.
The deal could take some pressure off CVS Caremark Corp, which has struggled to quiet critics who say that the $27 billion merger of CVS with the Caremark PBM in 2007 has not lived up to its promise and has been a drag on profitability.
CVS may also pick up some PBM business in the coming year from clients concerned that Express Scripts and Medco will be too distracted by their merger efforts.
CVS shares rose 2.6 percent to $37.90, while Express Scripts shares rose 6.1 percent to $55.76.
Shares of Rite Aid Corp, a distant No. 3 in the drugstore industry, were up 4.6 percent to $1.36.
While Walgreen may need to take a more conciliatory approach with Express Scripts, it may also become more aggressive in acquiring drugstores to preserve its clout, said Smead. His fund has held Walgreen shares for 3-1/2 years. CVS may take the same tack, he said.
Other retailers with pharmacies, such as Kroger Co, Target Corp and Wal-Mart Stores Inc either could not be immediately reached or declined to comment.
WILL WALGREEN RECONSIDER?
Express Scripts has said that Walgreen gives its clients smaller discounts than other drugstores do. Walgreen finds Express Scripts' rates "really, really below standard," but may have little room to play hardball.
"This really hurts Walgreens. It has definitely tipped the scales in that discussion," said Jefferies & Co analyst Arthur Henderson, who covers the PBM industry.
Raymond James analyst John Ransom estimates that losing the business of a combined company would hit Walgreen's annual earnings per share by $1.00. Analysts are expecting the chain to have an EPS of $2.63 this year.
Walgreen has already sold off its PBM to Catalyst Health Solutions Inc, potentially leaving it further exposed to major PBMs. In 2010, Walgreen fought with rival CVS Caremark, whose PBM stands to be the second-largest after the merger.
Prescriptions make up two-thirds of Walgreen's revenue and draw in shoppers who buy general merchandise such as suntan lotion and food when they come in for their medications.
Jefferies & Co drugstore analyst Scott Mushkin said that the Express Script-Medco deal, which comes at the time of year when PBMs most actively try to land contracts with large employers, could prompt some to chose CVS Caremark rather than the huge combined Express Script-Medco.
After stumbling in 2009 and losing a major contract, CVS Caremark is having a good selling season this year, landing a major contract with the Federal Employee Program.
(Additional reporting by Lewis Krauskopf in New York; Editing by Michele Gershberg and Gerald E. McCormick)