medco (mhs) bench

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MedcoHealth Solutions MHS (NYSE) Keith Fenderson Ainsley Woolridge Mike Mathis The Nittany Lion Fund, LLC Penn State Investment Association Healthcare MHS expected to report Nov 1

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Page 1: Medco (MHS) Bench

MedcoHealth SolutionsMHS (NYSE)

Keith FendersonAinsley Woolridge

Mike Mathis

The Nittany Lion Fund, LLC.

Penn State Investment AssociationHealthcare

MHS expected to report Nov 1

Page 2: Medco (MHS) Bench

Team Recommendation: Bench

Introduction

Description

Key Drivers Valuation Conclusio

n

•Drug Trends

1

•Retaining and Growing Value

2

•Supplementing Core Op’s

3

•12 Month Price Target:

$72

•Appropriate Entry Price:

< $57

Top Three Reasons to Purchase:

Page 3: Medco (MHS) Bench

Company Description► Medco is a pharmacy benefits manager

(PBM), which acts as the middle man between drug companies and pharmacies. PBM’s use their size and scale to purchase drugs at discounts, and then provide the drugs along with proprietary services to client pharmacies. Members fill their prescriptions through a network of 60,000 pharmacies, a mail-order program, or the company's call-center and Internet pharmacies. In addition, Medco is the largest provider of specialty drug and pharmacy services in the rapidly growing US market under their Accredo brand. They dispense specialty drugs for rare/severe chronic illness, usually injectable or infusion drugs, to patients with serious diseases, e.g. cancer and hemophilia. Medco manages drug benefits for clients that include unions, corporations, HMOs, and federal employees

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 4: Medco (MHS) Bench

Revenue Breakdown

Introduction

Description

Key Drivers Valuation Conclusio

n

100% US RevenueInternational EPS

contribution likely to begin in 2015

International Expansion into key European markets

Tremendous amount of interest in Medco software and services from European Government-run HC 83%

17%

Revenue BreakdownPBM Specialty Pharmacy

Page 5: Medco (MHS) Bench

Competitive Landscape

Introduction

Description

Key Drivers Valuation Conclusio

n

► Express Scripts (ESRX)► PBM services include retail network pharmacy

management and retail drug card programs; home delivery pharmacy services; specialty pharmacy services; patient care contact centers; benefit plan design and consultation serving HMOs, health insurers, third-party administrators, employers

► CVS Caremark (CVS)► Pharmacy services operating in two segments,

Pharmacy Services and Retail Pharmacy. The Pharmacy Service segment provides a range of prescription benefit management services, including mail order pharmacy services

► Catalyst Health Solutions (CHSI)

► Small cap PBM that provides its clients access to a contracted national network of approximately 63,000 pharmacies

Page 6: Medco (MHS) Bench

Drug Trends► Medco is set to capitalize on the $80-90 billion generic wave over next five years, with

2011 being the weakest contributor through 2020► $29 billion of drugs coming off patent in 2012 estimated $.60-$.65 EPS

contribution in the year alone► Medco makes 5-10x more profit on generic drugs

► Currently 5/10 top grossing drugs are biologics, and by 2016 that will increase to 9/10► Pending formal FDA approval process for biosimilars (generic biotech)► 46 biotech products ($42.3bb) coming off patent through 2020► Over 611 specialty compounds currently in phase II, III testing► 2010 prescription volumes up 6.5% to a record 957 million prescriptions, generic

dispensing rate rose 3.5 to 71%► 2010 Mail-order generic dispensing rate up 3.7 to a record 61.5%

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 7: Medco (MHS) Bench

Drug Trends

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 8: Medco (MHS) Bench

Retaining & Growing Value► Highest client retention rate among competitors at >99%

► ~95% for ESRX, ~97-98% for CVS► $5.3 billion in net new sales in 2010, $1.5 net new sales at

year end for 2011► Incredibly high barriers to entry in PBM industry due to

scale, pricing power, high desired service level in long term customer relationships

► Earnings growth from demographic, legislative, and generic shifts will be significantly compounded by mail order service and utilization

► Worlds largest mail order pharmacy allows members to order longer three month prescriptions which results in substantially higher margins and higher adherence

► Entrance into online OTC drug market► First and only Prescription Drug Provider to ever win 5

stars from Governmental Center for Medicare/Medicaid Services’

► Medco Topped Industry on Fortune's List of 'World's Most Admired Companies' for Fourth Consecutive Year in 2011Introducti

onDescriptio

nKey

Drivers Valuation Conclusion

Page 9: Medco (MHS) Bench

Supplementing Core Op’s

► Medco is the nation’s leader in specialty pharmacy care through its subsidiary Accredo Directly tied to growth in biologics

► Focuses on specialty medicines expensive and difficult to administer, that are used to treat chronic and life-threatening diseases

► Specialty pharma to be a significant driver of growth/ margin expansion

► 17% of sales in 2010, 30% of sales in 2015► Clients look for a full value proposition when choosing benefits

manager► Unparalleled proprietary services combined with bolt-on

acquisitions► United BioSource acquisition “makes medicine smarter”

by promoting medical treatment based on research evidence

► Post-approval testing (Phase IV) for safety, economic cost-benefit evaluation, and outcomes research

► UBC anticipates sales will have an annual growth rate of 20%

► “With its global presence and emphasis on post-approval drug research that is designed to guide the safest and most efficient use of the most effective medicines, this acquisition is perfectly aligned with our broader strategy to ‘make medicine smarter,’”

David B. Snow Jr., Medco Chairman and CEO

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 10: Medco (MHS) Bench

Supplementing Core Op’s

► Medco Research Institute ► Closes the gap between scientific discovery and medical

practice in order to make healthcare more precise► The Center for Therapeutic Resource - pharmacy specialists

driving adherence► Poor drug adherence and mismanagement account for

>$350b in waste/ yr► Omission gaps are not uncommon, TRC monitors

prescription drug use in patients with chronic conditions and aims to close these gaps

► Personalized medicine and genetic testing represents $10-15 billion market

► Medco has positioned itself for market leading genomic research through its acquisition of DNA Direct

► Pharmacogenetics improve care and lower overall healthcare costs

► Creates less waste, greater dosing precision, reduced risk of adverse affects and higher probability of a successful therapy

► Genomic services gaining traction in the market place; 9 out of 10 doctors want to integrate genetic testing will be the future way of care

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 11: Medco (MHS) Bench

Comparable Analysis

Introduction

Description

Key Drivers Valuation Conclusio

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Page 12: Medco (MHS) Bench

Comparable Analysis

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 13: Medco (MHS) Bench

Five Year Summary

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 14: Medco (MHS) Bench

Projections

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 15: Medco (MHS) Bench

Growth Analysis & CAGRS

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 16: Medco (MHS) Bench

Discounted Cash Flow

Introduction

Description

Key Drivers Valuation Conclusio

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Page 17: Medco (MHS) Bench

One Year Stock Chart

Introduction

Description

Key Drivers Valuation Conclusio

n

3/18/11: Medco was sued by a member of CalPERS’ health plan alleging that CalPERS members had

been paying too much for medications

7/22/10: Medco earnings missed

analyst expectations by

$0.02

8/16/10: Medco announced the

purchase of United BioSource for

$730MM

11/2/10: Medco beat earnings and raised its full-year earnings estimate

Page 18: Medco (MHS) Bench

Company and Sector Risk► CalPERS contract loss due to controversy

over $4mm paid to board member for “consulting fees” who was then retained as a consultant

► Medco likely not the target of federal investigations

► Two large clients up for renewal: Federal Employee Program & UNH

► Negotiations will begin with UNH this summer

► FEP will likely decide renewal in May► Weaker than expected new business wins or

client retention► Competitive pressure on profitability metrics

► Competitors desperate to win contracts may bid irrational pricing

► Difficulties surrounding the integration of recent acquisitions (e.g. UBC)

► A potential slowdown in prescription drug utilization growth

Page 19: Medco (MHS) Bench

19

Risk Analysis

Benchmark Risk

Sub-Sector

Geographic

Valuation

Market Cap

Company Specific

Valuation

Earnings

Volatility (Beta)

Acquisitions

Momentum

Industry Specific

Regulation

Relative Service Level

Contracts

0 1 2 3 4 5

0 1 2 3 4 5 Notes

12.9x forward pe to 19.3x industry avg

Integration critical

No fees, taxes, would benefit from overhaul

Page 20: Medco (MHS) Bench

Debt & Correlation

Introduction

Description

Key Drivers Valuation Conclusio

n

Page 21: Medco (MHS) Bench

Questions or Comments?

MHS expected to report Nov 1

Page 22: Medco (MHS) Bench

Sector Strategy

Introduction

Description

Key Drivers Valuation Conclusio

n

Our services exposure, Wellpoint, has run up ~21% nominally YTD, while many fundamental issues and risks remain in the managed care industry Potential for more adverse legislation traded down on

Obama’s budget plan Historically HMO’s have traded at 13-18x, currently at 10x

While we still think that there is more room for multiple expansion, we feel that we need to be prepared to make a move after earnings season

We would wait until after Medco reports April 28th, and then look for further clarity on FEP contract and CalPERS

Page 23: Medco (MHS) Bench

JP Morgan Report Highlights

Introduction

Description

Key Drivers Valuation Conclusio

n

Lisa Gill ranked #1 Healthcare analyst Most bullish on PBM’s for 2011 and Medco specifically (OW $78 PT)

CalPERS Believes CalPERS has a marginal impact– itself was only $500mm sales Only issue might be with Government contracts, and harder sell for new

clients Federal Employee Program- FEP (renewal decision expected in may)

FEP mail order contract .22-.31 in EPS *Medco mail order business is twice as big as ESRX and CVS, more

service offerings United Health Group contract (End in 2012)

Potential for UNH to internalize contract over 2013-2015- Expectation priced in

$.24-$.27 of 2010 EPS (6-8%) Worst case- $.60 overall potential impact of CalPERS, United, FEP,

and some key renewals See last slide

Most clients have long standing relationships with Medco. Members are more concerned with service level. Already Medco reps have reached out to clients to explain issue aside

Page 24: Medco (MHS) Bench

Appendix

Introduction

Description

Key Drivers Valuation Conclusio

n

Valuation Summary5 Year Rel to

Current High Low AvgIndustry

P/ E (LTM) 17.6x 37.3x 16.2x 26.0x 0.8x

P/ E (NTM) 12.9x 23.5x 11.6x 17.9x 0.8x

PEG (NTM) 0.7x 1.3x 0.7x 1.1x --

P/ CF 10.2x 40.3x 7.3x 16.2x 0.8x

P/ Sales 0.3x 0.6x 0.3x 0.5x 0.4x

EV/ EBITDA 8.9x 15.7x 7.7x 11.8x 0.8x

5 Yr FCF CAGR 18.2%

Profitability 31-Dec-10 31-Dec-09 31-Dec-08 31-Dec-07

Return on Assets 8.2% 7.3% 6.6% 6.0%

Return on Equity 27.5% 20.7% 17.2% 12.7%

Return on Avg. Total Capital 14.7% 12.2% 10.5% 9.5%

Return on Avg. Invested Capital 14.7% 12.6% 11.2% 10.0%Efficiency

Inventory Turnover 53.9x 35.7x 25.1x 23.1x

Days of Inventory on Hand (DIO) 6.8 Days 10.2 Days 14.5 Days 15.8 Days

Total Asset Turnover 3.9x 3.3x 3.0x 2.7x

Page 25: Medco (MHS) Bench

Appendix (Cont.)

Introduction

Description

Key Drivers Valuation Conclusio

n

Currently trading at 12.9x 2011E EPS versus 18.5 historical forward EPS

EPSLOSS 2012 EPS 15x 16x 17x 18x 19x

0.0 $4.97 $74.54 $79.50 $84.47 $89.44 $94.410.1 $4.87 $73.04 $77.90 $82.77 $87.64 $92.510.2 $4.77 $71.54 $76.30 $81.07 $85.84 $90.610.3 $4.67 $70.04 $74.70 $79.37 $84.04 $88.710.4 $4.57 $68.54 $73.10 $77.67 $82.24 $86.810.5 $4.47 $67.04 $71.50 $75.97 $80.44 $84.910.6 $4.37 $65.54 $69.90 $74.27 $78.64 $83.010.7 $4.27 $64.04 $68.30 $72.57 $76.84 $81.110.8 $4.17 $62.54 $66.70 $70.87 $75.04 $79.21

Forward PE

2011 Implied Value