Omnicare Bids for PharMerica to Surf the Generic Wave

Omnicare (NYSE:OCR) made a surprise hostile bid for competitor PharMerica (NYSE:PMC) yesterday. See Omnicare Proposes to Acquire PharMerica for $15.00 Per Share in Cash.

The combined companies would have more than half of the long-term care pharmacy market IF the deal happens. (PharMerica rejected the bid.) Wall Street signaled initial comfort with the antitrust risk when PMC’s stock price jumped 27% yesterday.

The real juice behind the deal is generic drugs. Once again, we see two major players combining to get more scale ahead of the coming generic wave.

Pity poor AmerisourceBergen (NYSE:ABC), which finds itself on the losing side of yet another big pharmacy market share shift.

A FEW WORDS ON LONG TERM CARE

The institutional pharmacy business operates as a hybrid of central-fill dispensing on behalf of individual patients combined with physical distribution on behalf of multiple patients located at a single site. Long-term care had a 6.6% prescription market share in 2010, up 9 basis points in 2009. See Chains in 2010: Winning.

Long-term care facilities are highly sensitive to service since third-party payers—primarily Medicaid and Medicare Part D—cover drug costs. As a result, local and regional competitors, including independent pharmacies, can outcompete the two large national players at a local level. Alternate site Group Purchasing Organizations (GPOs) such as MHA help by leveling the acquisition cost playing field for the smaller companies. Both Omnicare and Pharmerica have had negative growth in the number of beds served in recent years.

You may recall that Walgreens (NYSE:WAG) got out of the long-term care business last year by exchanging its long-term care pharmacy business for Omnicare’s infusion business. See Walgreens and Omnicare Play Switcheroo.

SURFING THE GENERIC WAVE

There are few financial details because the announcement only reflects an offer by Omnicare, not a signed deal. Nevertheless, generic synergies will be significant given the very different purchasing strategies of the two companies.

Omnicare has a well-developed direct purchasing program for generic drugs and a re-energized management team under ex-McKesson executive John Figueroa.

In contrast, PharMerica must purchase all drugs—brand-name drugs as well as generics—from AmerisourceBergen under a prime vendor agreement, a legacy of the company’s history. PharMerica Long-Term Care was spun off from ABC in 2007 and combined with Kindred Pharmacy Services to form the PharMerica Corporation. Its current wholesaler agreement (from 2011) expires in September 2013 and reportedly provides somewhat better generic economics for PharMerica, but certainly worse than a direct relationship.

Omnicare wants more scale going into the upcoming wave of newly-generic drugs, especially since the launch period provides maximum generic profitability for everyone in the drug channel (including long-term care pharmacies). Key drugs for the silver-haired folks in long-term care facilities will be generic soon, including Plavix, Seroquel, and Zyprexa.

The difference in purchasing strategies shows up in each company’s respective margins. Omnicare’s gross margin was 22% in the most recent quarter vs. PharMerica’s 14% gross margin.

Omnicare also has a much stronger position in specialty drugs, which represent about 15% of revenue. Many people don’t know that Omnicare also operates the reimbursement hub RxCrossroads and the specialty pharmacy ACS.

MORE BAD LUCK FOR ABC

I estimate that PharMerica represents about $1.6 billion in business for ABC, which is roughly 1.9% of ABC’s U.S. drug distribution business. The post-acquisition business would presumably shift to Omnicare’s supplier, McKesson (NYSE:MCK).

Poor ol’ ABC can’t catch a break. This announcement is the third big potential business shift in the few two months that hurts ABC and helps McKesson. The others:

• CVS Caremark’s FEP contract win will shift about $1.8 billion in revenue from AmerisourceBergen (NYSE:ABC) to McKesson (NYSE:MCK). See Interpreting Caremark’s Big Win over Medco.
  
  
• If the Express Scripts (NASDAQ:ESRX)-Medco Health Solutions (NYSE:MHS) goes through, then ABC would lose about $14.4 billion in revenue. (Actually, it will be less because of Medco’s market share losses.) See ESRX-MHS: Wholesalers, Other PBMs, and Walgreens.

Don’t forget that ABC also lost business to Cardinal Health (NYSE:CAH) when CVS Caremark (NYSE:CVS) bought Longs and Walgreens (NYSE:WAG) bought Duane Reade. This year, it will take an estimated $800 million revenue hit from the loss of the U.S. Oncology logistics business following McKesson’s acquisition. On the plus side, ABC picked up the Humana business.

Looks like Steve Collis will be have an interesting (?) growth challenge over the next few years. (See What’s Next for AmerisourceBergen.)