Cigna’s $67 billion acquisition of ESI: The largest transformation yet in the PBM market

On March 8, 2018, Cigna—the fourth-largest U.S. commercial health insurer—announced its acquisition of Express Scripts Holding Company (ESI), the largest independent third-party pharmacy benefit manager (PBM) in the United States. Including ESI’s debt, the deal is valued at up to $67 billion. This transaction signals the near disappearance of large, independent third-party PBMs in the U.S. and validates Latitude Health’s earlier assessment of the U.S. PBM market: “Truly independent, third-party PBMs may struggle to sustain long-term growth; instead, PBMs controlled by or partially owned by payers will become the dominant market participants” (see Latitude Health’s December 2017 research report, *Opportunities in Ancillary Services Amid the End of the Payment Bonus Era*). Following Aetna’s (the third-largest U.S. insurer) and CVS Health’s (the second-largest independent PBM) merger announcement in 2017, market speculation intensified regarding a potential sale of ESI. Key challenges facing the PBM industry include eroding trust from payers toward independent third-party PBMs. For instance, Anthem—the second-largest U.S. commercial insurer—has declined to renew its contract with ESI, the largest independent PBM; similarly, Aetna—the third-largest commercial insurer—has explicitly stated that third-party PBM services offer limited real value in cost containment. In 2016, thirty (now forty) major U.S. corporations formed the Health Transformation Alliance (HTA), a self-insured employer coalition. Although HTA still partners with PBMs—including CVS and OptumRx—it mandates full price and process transparency, joint formulary development, and audit rights for every transaction, all aimed at reducing pharmaceutical spending. Such payer-driven demands have placed immense pressure on the PBM market, ultimately triggering profound structural change. In 2016, ESI reported total revenue of $100.2 billion, down 2% year-on-year. Of this, $96.5 billion came from PBM operations, with the remainder derived from other services such as research and analytics, and patient assistance programs. Within ESI’s 2016 PBM revenue, $5.14 billion—51% of total revenue—came from retail pharmacy. However, this segment has been in continuous decline since 2014: it fell 3% in 2015, 9% in 2016, and 5% in the first three quarters of 2017.

Data Snapshot: Hong Kong & U.S. Markets | Super Earnings Week Arrives—Which U.S. Stocks Are Most Likely to Beat Expectations?

• Historically, the company has exceeded earnings expectations at least 80% of the time (i.e., probability of beating estimates ≥80%). • Average stock price gain on the day of earnings release is at least 1%. Key Highlights • Among companies reporting earnings this week, software firm ServiceNow (NOW) ranks first for highest average same-day stock price gain following earnings releases—3.3%. NOW will report earnings on October 26 (U.S. Eastern Time) and has beaten earnings expectations 88% of the time historically. • Tech giant Apple Inc. (AAPL) is also on the list, reporting earnings on October 27 (U.S. Eastern Time). According to Bespoke Investment Group, Apple has beaten earnings expectations 89% of the time historically, with an average same-day stock price gain of 1.2%. JPMorgan recently reaffirmed its “Overweight” rating on Apple shares, noting that investor attention remains focused on the iPhone despite recent reports about possible production cuts. Analyst Samik Chatterjee wrote in a report last Friday: “In a year where investor sentiment has shifted from bearish (e.g., expecting revenue declines) to bullish (e.g., anticipating modest revenue growth), every growth driver matters.” One area JPMorgan specifically highlighted is Apple’s new smartwatch. “Here, we are assessing the near- and long-term growth opportunities arising from Apple’s recent entry into the premium smartwatch segment; currently, Apple appears to have substantial room for further premium pricing.” • Financial services company Mastercard (MA) is also on the list, reporting earnings on October 27. MA has beaten earnings expectations 94% of the time historically, with an average same-day stock price gain of 2%. • Bespoke Investment Group data also shows Teledyne (TDY) has consistently beaten earnings expectations, with an average same-day stock price gain of 2%. TDY will report earnings on October 26. • Other stocks on the list include: Grand Canyon Education (LOPE), Monolithic Power Systems (MPWR), Manhattan Associates (MANH), Element Solutions (ESI), Wolfspeed (WOLF), F5 Networks (FFIV), Amphenol (APH), Costa (CSGP), Costamare (CMRE), Reliance Steel & Aluminum (RS), Silicon Laboratories (SLAB), S&P Global (SPGI), SPS Commerce (SPSC), Deckers Outdoor (DECK), John Bean Technologies (JBT), Valero Energy (VLO), Polaris (PII), and Booz Allen Hamilton (BAH).

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