Recent "purchase power combination plays" by drug chains and pharmaceutical distributors underscore the urgency to build scale in the global prescription drug channel, according to a report by Fitch Ratings.

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'Purchase power plays' highlight the drive for scale in global pharmaceutical channel

January 16th, 2014

NEW YORK – Recent "purchase power combination plays" by drug chains and pharmaceutical distributors underscore the urgency to build scale in the global prescription drug channel, according to a report by Fitch Ratings.

The rating agency said Wednesday that the business combinations between CVS Caremark Corp. and Cardinal Health Inc.; Walgreen Co., Alliance Boots and AmerisourceBergen Corp.; and the unsuccessful bid by McKesson Corp. to acquire Germany-based drug distributor and drug store operator Celesio AG may pave the way for more deals by other large players looking to ramp up scale in the buying and selling of pharmaceuticals.

Fitch noted that big drug buyers thus far not involved in such "purchase power combination plays" include pharmacy benefit manager Express Scripts Inc., the largest U.S. PBM; Rite Aid Corp., the third-largest U.S. drug chain; and Phoenix Pharmahandel Aktiengesellschaft & Co KG, a European drug distributor.

"It seems as though most of the largest firms have chosen their partners. But Fitch expects this trend will continue and allow for greater generic profits and efficiencies for the drug channel in the intermediate and longer term," the rating agency said in its report.

The latest deal came in December, when CVS Caremark and Cardinal Health announced  plans to form a 50/50 joint venture that they called the largest generic drug sourcing entity in the United States. The companies said the venture — to be operational as soon as July 1, 2014, and have an initial term of 10 years — will source and negotiate generic supply contracts with generic drug makers for both Cardinal Health, the second-largest U.S. drug wholesaler, and CVS Caremark, which operates the No. 2 U.S. drug chain and PBM.

Walgreens, the largest U.S. drug chain, announced in June 2012 that it would acquire a 45% equity interest in Alliance Boots, a global pharmaceutical, health and beauty retailer and wholesaler, for $6.7 billion in cash and stock. That part of the two-step deal was completed in August 2012. Under the agreement, Walgreens has the option to buy the remaining 55% of Alliance Boots in the following three years for $9.5 billion in cash and stock. At the end of October 2012, Walgreens and Alliance Boots formed a joint venture company, Walgreens Boots Alliance Development GmbH, based in Bern, Switzerland. Alliance Boots has its operational headquarters in the United Kingdom but is based in Switzerland.

Then in March 2013, Walgreens and Alliance Boots unveiled a long-term partnership with U.S. drug distributor AmerisourceBergen Corp. The three-part strategic agreement calls for AmerisourceBergen, under a 10-year primary distribution pact with Walgreens, first to distribute brand-name drugs that the drug chain has historically sourced from other distributors and suppliers and then, beginning in calendar year 2014, to increasingly include generic drugs that the chain has typically self-distributed. AmerisourceBergen became Walgreens' primary supplier of branded drugs starting this past September.

In the second part of the deal, AmerisourceBergen will access generics and related pharmaceuticals through the Walgreens Boots Alliance Development GmbH. The third part of the agreement enables Walgreens and Alliance Boots to buy an equity stake in AmerisourceBergen, for which they received regulatory clearance in May.

McKesson's plan to buy Celesio was announced this past October. The complex deal, initially valued at $8.3 billion, would have united the biggest U.S. drug distributor with one of the world's largest wholesalers and providers of logistics and services to the pharmaceutical and health care sectors. However, despite upping its offer last week, McKesson said Monday that its bid fell through after it failed to gain the necessary shareholder support. Published reports this week have said McKesson is now mulling other options, including a potential joint venture with Celesio.

"The forms of these business combinations are diverse, both in their structure and progress," Fitch said in its report. "But each relationship makes sense for those involved as scale increasingly matters in health care, particularly in the buying and selling of pharmaceuticals."

In its analysis, Fitch pointed out that most of the big drug channel players have sourced and distributed most of their generics.

"The AmerisourceBergen-Walgreens agreement is the starkest change from this model, as AmerisourceBergen will distribute virtually all drug volumes to Walgreens, likely by year-end 2014. The Cardinal/CVS agreement could signal a shift in a similar direction, but nothing has indicated that to be the case yet," Fitch explained. "There are notable differences in the arrangements, although amassing scale is common to all of them."

Meanwhile, the largest generic drug manufacturers also have been building up scale over the past several years, according to Fitch.

"Today, the four largest generic drug firms — Teva Pharmaceutical Industries Ltd., Sandoz (a division of Novartis AG), Actavis Inc. and Mylan Inc. — together represent a significant portion of generic drug volumes in the U.S. and Europe," the rating agency observed in its report. "Fitch expects that consolidating purchasers could pose a threat to these firms' profitability in the intermediate term."

Most likely, midtier and smaller generic drug makers will be impacted the most by combinations of large purchasers.

"Smaller generic firms may not be able to supply the quantity of product demanded by the new global drug purchasers and, thus, may miss out on key contracting opportunities going forward," Fitch stated. "Especially as the largest generic firms expand into emerging markets, where access to health care and acceptance of generic drugs is generally improving, smaller generic firms are likely to encounter growing competitive pressures."