Image source: Express Scripts.
You might say that Express Scripts (ESRX) has a bad case of the blues lately. Its stock plummeted in the weeks following a public statement by Anthem (ELV 0.15%), the largest Blue Cross and Blue Shield plan, that it could part ways with the big pharmacy benefits manager. Does this threat from Anthem make Express Scripts a risky bet for investors? Nope. Here's why.
Count the money
What would the financial impact be to Express Scripts if Anthem does bolt? In 2014, the health insurer accounted for roughly 14% of Express Scripts' revenue. If we assume that percentage is still applicable, the Anthem business generated around $14 billion in revenue last year for Express Scripts.
For 2015, Express Scripts reported earnings just below 2.5% of total revenue. Using that metric, the PBM probably made in the neighborhood of $350 million in earnings from Anthem last year. That's a big number -- and it would definitely hurt Express Scripts to lose those profits.
Consider this, though: Since Anthem announced that it could end the relationship with the giant PBM, Express Scripts' market cap has fallen around $11 billion. That's more than Express Scripts would generate in earnings from Anthem's block of business over the next few decades.
Getting stickier
Of course, one could argue that the loss of a premier customer like Anthem might make Express Scripts less attractive to other customers. There are a few reasons, though, why that argument doesn't hold up to scrutiny.
When questioned about what impact the Anthem situation has had on existing customer or selling to new prospects in the fourth-quarter earnings call, Express Scripts President Tim Wentworth responded with "zero." He noted that the company recently renewed a key relationship with a large health plan for another three years in the midst of the discussions with Anthem.
Based on a strong outlook for 2016, Express Scripts raised the lower end of the earnings range expected for the year. That confident stance certainly doesn't seem to hint at any concerns about losing too many customers. Express Scripts doesn't have to worry about losing its second-largest customer, the U.S. Department of Defense, anytime soon. The DOD extended its contract in 2014 for another seven years.
Actually, Express Scripts' customer retention rate of 97% over the past year is the strongest ever for the company. CEO George Paz probably wasn't exaggerating when he said that Express Scripts' business model "has never been more relevant than it is today." Customers need to control pharmacy costs -- and Express Scripts has proven to be pretty good at accomplishing that goal.
The fat lady hasn't sung
There's also one little detail to factor into any discussion of Express Scripts' risk: Anthem hasn't gone anywhere yet and might not do so at all. The possibility that Anthem leaves is already more than baked into Express Scripts' share price, but what if Anthem stays?
The two companies continue to negotiate on the contract. While it's certainly possible that those talks fall through, I think the likelihood of a deal being struck is high.
Express Scripts won't give up $3 billion like Anthem wants, but the PBM probably will offer to make some significant financial concessions. My guess is that Express Scripts will trade those concession in return for Anthem extending the contract beyond 2019 and participating in additional programs offered by the PBM that could help save money for both organizations.
Anthem either cuts a deal with Express Scripts or finds another PBM. There isn't enough time for the company to build its own PBM to support all of its operations. I would be shocked if any rival to Express Scripts would offer anywhere close to the figure that Anthem says it wants. In the end, this could very well just be a shrewd negotiating ploy by one of the largest health insurers in the country.
A new tune
Investing in any stock comes with risk. Express Scripts is no exception. However, my view is that the PBM's stock is actually less risky now than it's been in quite a while.
The market's negative reaction to the Anthem uncertainty was overblown, in my opinion. That response, though, has made Express Scripts more attractively valued than it's been in years.
ESRX P/E Ratio (Forward 1y) data by YCharts.
Even if Anthem bailed out, the impact to Express Scripts' earnings wouldn't be large enough to dramatically change the valuation picture for the PBM. And if Anthem stays (as I think it will), Express Scripts' shares will likely soar. Express Scripts might be singing the blues now, but investors could soon be whistling a happy tune.
