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A Drug Company On Growth Hormones


When Medco Health Solutions Inc. was part of drug giant Merck & Co. in the 1990s, investors paid scant attention to the pharmacy benefits unit. After all, it was a low-margin group with a less-than-sexy business: managing pharmacy benefits for big employers and health plans. That's one reason Merck ended up spinning the company off to shareholders in August, 2003.

Investors sure aren't blasé these days. Since the spin-off, Medco's stock is up over 87%, thanks to a host of developments including a growing mail-order drug operation, the expectation of new Medicare business, and the anticipated benefit of increased generic drug use. And now, with the company's announcement on Feb. 23 that it would pay $2.2 billion for specialty pharmacy services company Accredo Health Inc., Medco is moving forcefully into the rapidly growing market for expensive biotech medications.

Paying a 43% premium for Accredo, Medco isn't getting any bargain. And investors sent Medco's stock down slightly on news of the deal. But they give Medco Chairman and Chief Executive David B. Snow Jr. credit for putting Medco in a position to capitalize on new opportunities.

FAT MARGINS

In Accredo, Medco is getting a small but fast-growing business that boasts healthy pretax margins of close to 8%, compared with Medco's overall margins of around 2%. What's more, biotech accounts for an increasing share of medical innovation. By adding Accredo to its portfolio, therefore, Medco gains a strong presence in the area of specialty drugs.

Snow, who joined Medco from New York insurer WellChoice Inc. a few months before the spin-off, clearly thinks Medco's newfound independence has a lot to do with its strong performance. There's no doubt that when Medco was a unit of Merck, potential customers were concerned that Medco's first priority was pushing Merck drugs.

Medco has long maintained that it operated with a free hand, but pharmacy benefits units "should not be owned by pharmaceutical manufacturers," asserts Snow. "If Medco had planned to stay under Merck, I would not have agreed to be its CEO."

Medco now has the ability to fully exploit major shifts in the drug business. One of the biggest: patent expirations on blockbuster pharmaceuticals. In 2006, drugs generating $12 billion in sales will lose patent protection. And Medco, which has more bargaining power with the smaller generic companies than with the big branded drugmakers, enjoys margins that are three times greater on generic drugs than on branded products.

Plenty of hurdles lie ahead. For one, legal issues continue to hover over pharmacy benefits managers. Medco is still fighting the U.S. Attorney's Office in Philadelphia in a case that centers on irregularities in the management of a contract with the federal government. Snow says Medco is prepared to fight that case in court. "Some of the biggest challenges are behind us," Snow argues. Being owned by a giant drugmaker may have been one of them.

By Amy Barrett in Philadelphia


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