Catamaran Sails Away with Cigna’s PBM: Deal Analysis

Last night, Cigna (NYSE: CI) ended months of speculation by announcing a 10-year PBM partnership with Catamaran (NASDAQ: CTRX). Check out the oddly-titled press release, which somehow omits Catamaran’s name from the headline: Cigna Retains and Builds On Success of Pharmacy Business Delivering Market-Leading Value to Customers. Or, click here to listen to the Catamaran conference call.

Catamaran wins big from the deal, because it (1) gains at least $5 billion in incremental revenues, (2) removes a major uncertainty about its business, and (3) can now credibly be called one of the Big PBMs. Cigna’s business will transition to Catamaran over the next 24-36 months.

By structuring the deal as an outsourcing arrangement, Cigna is showing confidence in the independent PBM model. The Catamaran-Cigna relationship looks more like CVS Caremark-Aetna outsourcing deal than the Express Scripts-Wellspring quasi-acquisition. Notably, Cigna did not follow UnitedHealth’s OptumRx strategy of insourcing the entire PBM.

Read on for my perspective on the deal.

MERGER MANIA BACKGROUND

The parties have a complex history.

In 2010, Healthspring, which was SXC Health Solutions’ largest customer, acquired Bravo Health, which had been a customer of Medco Health Solutions.

In early 2012, Cigna acquired health plan Healthspring. Cigna operates its own in-house PBM, including a mail pharmacy (Cigna Tel-Drug). This created speculation that Cigna would in-source Healthspring/Bravo.

Shortly after the Healthspring deal closed, SXC announced the acquisition of Catalyst Health Solutions in a deal that brought together the two largest, fastest-growing mid-market PBMs. See The SXC-Catalyst Merger: Initial Thoughts On the Deal.

The SXC-Catalyst combination was renamed Catamaran. The company estimates its PBM market share to be 6%. According to George Hill at Citi research, the Healthspring/Bravo business currently represents more than 20% of Catamaran’s estimated 2013 revenue.

WHICH WAY?

Cigna had three major models to follow for its internal PBM.

• In-source (UnitedHealth): In 2011, UnitedHealth decided to shift its commercial PBM business from Medco Health Solution to its internal OptumRx subsidiary. This decision laid the groundwork for the Express Scripts-Medco Health Solutions deal.

• Fully Outsource (Wellpoint): In 2009, Express Scripts signed a 10-year PBM deal for NextRx, WellPoint’s in-house PBM. The transaction has been very profitable for Express Scripts, which realized enormous operating and tax synergies from the transaction.

• Selectively outsource (Aetna): Under the 2010 Aetna-CVS Caremark 12-year contract, CVS Caremark manages purchasing, inventory management and prescription fulfillment of Aetna’s mail order and specialty pharmacy. It also provides administration of selected functions for Aetna's claim processing, customer service, retail pharmacy network contracting, and "physician engagement through e-prescribing." However, Aetna controls medical and pharmacy policy, formulary design, pharmacy/medical benefit integration, rebate contracting, and many other core PBM functions. For more details, see CVS-Aetna: Less Than Meets The Eye?

THE DEAL

As I see it, the Cigna-Catamaran arrangement is closest to the CVS Caremark -Aetna deal. According to the initial disclosures:

• Cigna will retain formulary management, clinical and product development, sales and marketing, and will manage “all day-to-day customer- and client-facing functions.”

• Catamaran will provide prescription drug procurement and inventory management, order fulfillment for Cigna's home-delivery pharmacy, retail network contracting, and claims processing. 

• Catamaran will remain behind the scenes, because the mail pharmacy and all pharmacy-related customer interactions will still have the Cigna brand.

• Cigna will lead the medical-pharmacy benefit integration activities.

Both sides benefit. Catamaran gets incremental volume (albeit at a lower-than-average margin) and removes a big uncertainty about its future. Meanwhile, Cigna benefits from scale economies in core PBM activities along with reduced cost-of-goods due to mail purchasing scale.

For example, the mail pharmacies of Cigna and Catamaran are both serviced by McKesson (NYSE: MCK). The combined business should be able to squeeze a few basis points from its wholesaler and mail-order suppliers.

On the conference call, Catamaran CFO Jeff Park reiterated the company’s intent to be a consolidator in the PBM middle market (per CEO Mark Thierer's comments in February). Stay tuned for more PBM consolidation deals, probably in late 2014 or early 2015.