One prediction that's sure to come true next year -- drug prices will rise. It's an old story, I know, but it remains a big one. Recent articles in The Wall Street Journal highlight the trend -- one piece pointed to exploding spending on expensive biotech drugs, and another commented on the high price of Celgene's (NASDAQ:CELG) recently approved drug, Revlimid.
So how can one profit from this inevitability? One pat answer is through investing in pharmacy benefit management (PBM) companies. Companies like Medco (NYSE:MHS), Caremark Rx (NYSE:CMX), and Express Scripts (NYSE:ESRX) make their way in the world as intermediaries negotiating lower prices from drug manufacturers and delivering those medicines to individuals covered under health plans from companies like General Motors (NYSE:GM). But it's also important to take stock of the environment in which PBMs operate.
One of the biggest developments has been intensified legal action designed to make PBMs more transparent. PBMs have traditionally been able to arrange deals with drugmakers without providing clients with details. These arrangements often involved rebates that were nice profit centers. However, a recent court case in Ohio and legislation in Maine are just the latest examples of a rising tide of demands that seek to have PBMs share more information on their business practices with clients.
In response, PBMs have promised to be more open, but doing so will probably lead to lower profit margins, since clients will surely demand at least part of the rebates. This suggests that the largest PBMs are likely to emerge as the strongest, since they can make up for thinner margins with higher volumes. On this basis, Medco appears to be a wise choice as an investment.
There's another possibility, though. If large PBMs continue to drag their feet, their clients are more likely to go elsewhere. This opens up opportunities for smaller players such as BioScrip (NASDAQ:BIOS). Still even smaller outfits will have to get bigger in a hurry to gain leverage in buying from drug manufacturers. For its part, BioScrip has a fairly strong balance sheet with no debt, and that situation should allow it to engage in acquisitions.
The year ahead promises to be trickier for those seeking to profit from PBMs. Keeping a close watch on how different PBMs respond to the transparency challenges should provide some indication of where the opportunities are.
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Fool contributor Brian Gorman is a freelance writer in Chicago. He does not own shares of any companies mentioned in this article.
