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Pfizer's New Headache
By
Bill Alpert, Barron's
October 10, 2005
Drug-benefit manager Express Scripts has yanked the beard of the biggest lion. Now, investors will see if it emerges a hero or gets mauled.Word got out last week that the St. Louis-based pharmacy-benefit manager (ticker: ESRX) will drop Pfizer's cholesterol-lowering drug Lipitor from the list of preferred drugs that it promotes to its clients. Instead, Express Scripts will push generic versions of Zocor, a rival cholesterol drug that goes off patent in June 2006.
In retaliation, Pfizer (PFE) is cutting off its rebate payments to Express Scripts next year. Rebates are a kind of refund given by a pharmaceutical maker to plans that put the drug maker's brands on a preferred list -- thereby enabling patients to get those brands with lower out-of-pocket spending. So Lipitor will become expensive for patients whose drug plans follow Express Scripts' lead. Generics save money for drug plans and are more profitable for a plan manager like Express Scripts.Lipitor, the world's biggest drug, generated $11 billion of Pfizer's $53 billion in revenue last year. Pfizer has incentive to make a public example of Express Scripts, because Lipitor's cost is an attractive target for health insurers everywhere. "It's a very exciting time," says Robert Seidman, chief pharmacy officer for health insurer WellPoint (WLP). "Generic Zocor is probably the largest cost-saving opportunity of this decade for the U.S. health-care system. If we were to attain a 25% market share for generic Zocor...that would save $2 billion" a
year.
The looming competition from generic Zocor, and legal attacks on Lipitor's patent protection, help explain why Pfizer shares languish at $24.39, barely 11 times next year's estimated earnings. Express Scripts, in contrast, has been one of hottest stocks in health care -- it's doubled in the past year to a recent $62.29. That share price is about 23 times next year's EPS estimate, and a 20% valuation premium to larger rivals Medco Health Solutions (MHS) and Caremark RX (CMX). With its shares at a perilous premium, Express Scripts must now sprint through 2006's first half with no rebates on big-selling Pfizer drugs like Lipitor -- a run Pfizer hopes to make painful for the impertinent benefit manager.The confrontation might have been inevitable.
Express Scripts pushes generics harder than most benefit managers. With programs that supply generics free to patients for the first six months, the company has boosted generic penetration to 54% of all prescriptions it processes. Drug costs slip 1%, says the company, for each percentage-point rise in generic penetration."This is business as usual for us," says Express Scripts spokesman Steve Littlejohn.
The company states that its independent medical advisers concluded that Lipitor didn't have to be on Express Scripts' national list of preferred drugs. Lipitor can be more potent than Zocor, which is sold by Merck. But Express Scripts says that research shows that 80% of Lipitor patients take the low-dosage formula, which is no stronger than Zocor. The benefit manager is keeping other high-potency cholesterol-fighting brands on the list, including Crestor from AstraZeneca (AZN) and Vytorin, a product jointly sold by Merck (MRK) and Schering-Plough (SGP). Zocor remains on the list, of course, and Express Scripts hopes to get as many patients as possible started on it now, so they'll move easily to generic versions after
June.
Express Scripts spokesman Littlejohn wouldn't discuss the details of its Pfizer business, or the profit impact of Pfizer's rebate retaliation. His company will answer questions on the September quarter earnings call on Oct. 27. The size of the Pfizer bite will depend on the market shares of cholesterol drugs sold by Express Scripts; its margins and rebate arrangements; and the amount of those rebates that it shares with its client drug plans. For example, if Express Scripts sells $700 million a year worth of Lipitor (10% of Pfizer's U.S. sales), and loses a 6% rebate from Pfizer (the average reported by the drug maker), it would miss out on $42 million -- which in turn might've been split 30/70 with its plan-sponsor clients. After tax, Express Scripts' 30% split would be perhaps $8 million, or about five cents a share. At a multiple of 23 times earnings, that would nick the stock a bit more than $1.But the cut might be deeper if Express Scripts sells a lot of other Pfizer products...or shallower, if it can shift a lot of patients to other cholesterol-fighting drugs. And after June, it will make nice margins on its sales of generic
Zocor.
UBS Securities analyst Ricky Goldwasser estimates that a benefit manager like Express Scripts can earn margins of 60%-80% on generics sold through its own mail-order pharmacy. That said, she's Neutral on the stock. At nearly 63, the shares seem to reflect no worries about the benefit manager's
prospects.
Pfizer spokesman Jack Cox says the drug giant has agreed not to discuss details of its fight with Express Scripts, but he does say that Pfizer expects no material financial impact. Pfizer also says that since Express Scripts told Lipitor to get lost, many drug plans have contacted Pfizer to arrange Lipitor deals
directly.
Even if other benefit managers aren't crossing Lipitor off their lists, they're doing what they can to diminish its popularity. WellPoint runs its own
pharmacy-benefit business, and pharmacy boss Robert Seidman says that the giant health insurer will give generic Zocor away to patients, and will supply physicians with samples, just as the branded drugs' salespeople do for their
products.
A number of forces will come together next year, says Seidman, to shift market share toward generics. Patent protection will lapse for big brands like Lipitor, as well as Pfizer's blood-pressure drug Norvasc and its antidepressant Zoloft. Benefit managers like WellPoint and Express Scripts will have refined their generic-incentive programs. Lastly, the new Medicare drug benefit will leave up to 30% of seniors with a gap in coverage, forcing them to pay full price for drugs. Seidman predicts that many will ask their doctors about relatively cheap
generics.
Drug companies like Pfizer may be old lions, but they're not dumb. They will find more opportunities to make benefit managers like Express Scripts feel the drug makers' pain.
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