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Express Scripts: Final Valuation

Express Scripts: Final Valuation. Ian Johnston. ESRX Background. PBM – Processes prescriptions for groups that pay for drugs (insurance companies or corporations) Services Processing prescriptions Mail-order pharmacy Negotiating lower prices with drug makers and sellers

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Express Scripts: Final Valuation

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  1. Express Scripts: Final Valuation Ian Johnston

  2. ESRX Background • PBM – Processes prescriptions for groups that pay for drugs (insurance companies or corporations) • Services • Processing prescriptions • Mail-order pharmacy • Negotiating lower prices with drug makers and sellers • Formulary management • Pass on cost savings to customers and take a cut

  3. Agenda • Significant Difficulties Encountered • Forecast Method • Assumptions • Growth • Profitability • Asset Turnover • WACC • Final Value and Stock Recommendation • DuPont Analysis

  4. ESRX Unique Issues • Merged with Medco in 2012 • Only two years of financial statements after the merger • Pre-merger financial information is unhelpful • Crude combination of ESRX and Medco financial statements yields sloppy and inconsistent data (for example, revenue would have declined for the “company” by 20% from 2011 to 2012) • Fails to take into account synergies • ESRX is a completely different company than two independent firms (Medco and ESRX) • Result: only two years of financial data available to use

  5. Issues Continued • No transcript of earnings call online • Analyst reports include built in growth rate assumptions of 10% to perpetuity • Highly competitive industry creates a lot of uncertainty around the growth rate • Mergers and acquisitions are common • Products being offered by PBMs are basically commodities • Market share hinges around large contracts with pharmacies and drug providers

  6. Forecast Method

  7. Forecast Method Add detailed break out of line items to income statement and balance sheet Add adjustments for leases and stock compensation Determine line-by-line growth rates from 2012 to 2013 Use growth rates and judgment based on account type to project out to 2022 Roll up accounts to get measures of NEA and EPAT to be used for forecasting

  8. 1) Breakout of Line Items • See spreadsheet • NEA-NFL tab • EPAT-FEAT tab • Items able to be broken out: • PPE • Goodwill/Intangibles • Deferred tax items • Pension obligation items (immaterial-left out of analysis) • Revenue breakout by product

  9. 2) Adjustments for Leases and Stock Comp NEA NFL EPAT/FEAT

  10. Line-by-Line Growth Rates • See spreadsheet • NEA growth rates tab • EPAT growth rates tab

  11. Projections to 2022 • See spreadsheet • Same tabs

  12. NEA/EPAT Projections • See spreadsheet • Same tabs

  13. Assumptions • Sales growth • 11% from 2012 to 2013 • Tapered down from 11% to 1.75% by 2022 • Reflects realization of synergies from merger, moving toward a mature PBM • Assumed long term growth rate in perpetuity: 1.75% • EPM • Slowly improves from less than 3% to over 5% through synergies from merger and cost efficiencies • Assumed long term EPM in perpetuity: 5.36%

  14. Assumptions • EATO • Increasing efficiency from 3.1 to 3.92 over horizon • Assumed long term EATO in perpetuity: 3.92 • WACC • Borrowing rate: 2.52% • Beta: 1.10 • Combination of Bloomberg (.97) and website estimates (1.17 average) • Risk free rate: 3.68% • Market premium: 7% • WACC for model: 9.44%

  15. Models • 3 models used to corroborate final value • Free cash flow • Residual income • Abnormal earnings growth • To reach steady state, forecasts were made 2023-2025 using long term sales growth, EPM, and EATO to assure steady state

  16. Final Value • Enterprise Value: $75,837,357,810 • Adjusting for date and mid-year rule: $81,583,009,570 • See spreadsheet • Models tab

  17. Buy, Sell, or Hold? Enterprise Value: $81,583,009,570 Subtract NFL: $15,175,420,000 Subtotal: $66,407,589,570 Divided by number of shares outstanding: 773,600,000 Implied stock value: $85.84 Current share price: $71.33 BUY RECOMMENDATION

  18. Comparative Analysis • Drug store industry is very heterogeneous • Combination of PBMs and Pharmacies • ESRX is a PBM giant • WAG is a pharmacy giant • CVS dabbles in both areas • WMT is a do-it-all firm • Comparison between firms gives little useful information due to different business models

  19. DuPont Analysis • Larger jump in ROE 2012 to 2013 • Drivers: • ROE = EPM * EATO+ LEV(RNEA – RNFL) • 2012: .0286 = .0132 * 2.42 + .693 (.0319 - .0368) • 2013: .0785 = .0195 * 2.88 + .725 (.0563 - .0256)

  20. Limitations to Analysis • Significant judgments and assumptions were made • Beta choice for WACC is a key input • Revenue growth all depends on market share and ability to provide a unique product • Very hard to do in the PBM industry- competition is fierce • Costs were assumed to run with sales, but an increase in the cost of drugs could drastically cut into margins • New regulation in the industry could increase costs or eliminate profits • Market share price may be lower for these reasons

  21. Questions?

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