WMT/HUM: Quick First Read Shows Little Compelling Benefit

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SEE END OF THIS REPORT FOR IMPORTANT DISCLOSURES

Richard Evans / Scott Hinds

203.901.1631 /.1632

revans@ / shinds@ssrllc.com

@SSRHealth

April 2, 2018

WMT/HUM: Quick First Read Shows Little Compelling Benefit

  • In theory, a WMT/HUM tie-up could improve Medicare Advantage (MA) recruitment for HUM, lower HUM’s costs of physician-office visits, pharmacy services, and durable medical equipment; and, help WMT defend its retail volumes
  • In practice, potential cost savings are limited. Only about 10% of the costs of delivering an MA benefit are more addressable by WMT than by HUM (the 7% of costs that come from physician office visits, the 3% from retail pharmacy dispensing mark-ups, and the < 1% from durable medical equipment (DME)). E.g. if WMT reduced the costs of physician office visits by 25% via on-site clinics, reduced the costs of DME 25% by pressuring suppliers, and cut its own pharmacy margins in half, it would only reduce the total cost of delivering the MA benefit by about 3.2%
  • In exchange for modestly lower premiums, presumably WMT/HUM beneficiaries go to a WMT clinic instead of their physician’s office, see a (potentially different each time) physician’s assistant rather than their (presumably the same each time) personal physician, and fill prescriptions at WMT (presumably on-site, rather than by mail). WMT/HUM beneficiaries almost certainly would not be eligible for AMZN Rx fulfillment, even at a higher co-pay
  • Our initial sense is that WMT can’t reduce the cost of the MA benefit enough to (setting aside WMT’s brand effects) substantially increase HUM enrollment, nor are the potential premium savings enough to reliably offset the associated loss of convenience, consistency, and/or choice to beneficiaries

We see three potential ways in which a WMT/HUM tie-up might improve these companies’ respective operations. At issue is how powerful these advantages might be, whether they require an outright acquisition to capture, and the whether the associated costs are worthwhile:

  • First, WMT might improve HUM’s recruitment of new lives. Persons newly in the market for individually-purchased health insurance (whether Medicare or commercial) often have little or no familiarity with the names of insurers; as such ‘wrapping’ an HUM offering in the WMT brand could offer obvious recruitment advantages
  • Second, along the lines of arguments made in favor of CVS/AET, in-store clinics in WMT locations might offer a lower cost ‘first touch’ setting as compared to the costs of traditional physician-office visits
  • Third, in theory a deal might serve to lock-up pharmacy lives (keeping them away from AMZN), and might further serve to ‘de-commoditize’ WMT’s prescription, health and beauty aid, and in-store clinic offerings, at least for HUM beneficiaries who might be offered special incentives on these products and services

Recruitment

Younger Medicare beneficiaries (aged 65-69) are somewhat less likely (35%)[1] than older beneficiaries (37%) to enroll in Medicare Advantage (MA). This may indicate that new beneficiaries are defaulting into traditional fee for service (FFS) Medicare rather than actively opting into MA, at least until they’ve been in the Medicare program for several years. The clear implication is that more active targeting of newly eligible beneficiaries might reasonably be expected to raise the percent opting into MA generally, and a WMT/HUM offering specifically. This potential benefit of a WMT/HUM combination could just as easily be captured in a more traditional arms-length relationship

Cost savings

Much of the cost of caring for Medicare beneficiaries occurs in settings that cannot realistically be appended to a retail location (Exhibit 1). A WMT/HUM NEWCO’s ability to buy these (e.g. Hospital) services on their clients’ behalf will depend on concentrated local purchasing share, a variable that WMT does little to change in HUM’s favor. WMT arguably could reduce the cost of caring for HUM beneficiaries by operating in-store clinics for less than physicians’ offices on a per-visit basis[2], accepting lower pharmacy dispensing margins[3], and/or squeezing costs out of durable medical equipment suppliers. The ‘Physician and Clinical Services’ category accounts for 22% of Medicare spending; however, the title of this category is somewhat mis-leading.

Of the services that fall into this broad category[4], only actual physician office visits (office / outpatient services and ophthalmological services) can realistically be performed in a WMT clinic, and these visits account for just 7% of total Medicare spending (Exhibit 2). If we add in retail pharmacy dispensing margins and durable medical equipment (DME), then we estimate that the combined services that can be shifted to a WMT setting account for just 10% of total Medicare spending (Exhibit 2, again), meaning 90% of the cost of caring for beneficiaries necessarily occurs off-site. If we aggressively assume that WMT absolutely wrings out any potential savings – e.g. 25% reduction in the cost of a physician office visit, 25% reduction in DME, and 50% reduction in pharmacy dispensing margin – this would lower the cost of caring for HUM beneficiaries by just 3.2% (and almost half of this theoretical savings comes from WMT reducing its own margins)

WMT arguably must lower its own margins to take costs out of an MA benefit, something it should only do if it’s guaranteed substantially greater volume, and/or can share in the underwriting margins captured by HUM. This implies a degree of control that in turn implies full acquisition of HUM; however, any premium paid for HUM could only be justified if WMT and HUM bring one another sufficient volume gains to offset both WMT’s margin concessions and the premium paid for HUM – and this level of volume gain is frankly difficult to imagine. As an added consideration HUM arguably doesn’t offer enough patient volume to drive full utilization of on-site WMT clinics. If WMT acquires HUM, WMT’s status as a competing underwriter could make other insurers less willing to include WMT’s in-store clinics in their networks

Lock-up / de-commoditize

As retail pharmacy networks narrow, and as a potential AMZN entry into pharmacy looms, locking up beneficiaries and/or de-commoditizing the retail pharmacy offering are obvious strategic priorities. Commercial (e.g. employer-sponsored) medical and prescription drug benefits tend to be of +/- 3 years duration; in contrast, enrollment in Medicare Advantage, or in a Part-D prescription drug plan (PDP) is renewed annually. So whatever WMT/HUM might do to get patients enrolled in their MA and PDP offerings, they would still have to meet the competitions’ offerings each and every year. For the sake of argument, we’ll presume the prospect of an AMZN entry into pharmacy is at least part of the motive behind a potential WMT/HUM tie-up

If WMT/HUM could offer MA coverage for substantially less than peers, this might reliably lock-up beneficiaries for relatively long periods regardless of how good a competitive pharmacy offering from AMZN might be – but for the reasons outlined above, we think it’s tough for WMT/HUM to dramatically lower the cost of providing an MA benefit, especially when the beneficiary-level trade-offs (a retail clinic as opposed to a doctor’s office, a physician’s assistant as opposed to your own physician, and a retail pharmacy as opposed to a potentially more attractive offering from AMZN) are considered. As we’ve argued elsewhere[5] current retail pharmacy offerings arguably set a very low bar. If AMZN enters pharmacy in the transformative manner we anticipate, the WMT/HUM tie-up might do relatively little to keep MA and PDP beneficiaries from considering competing offerings that incorporate AMZN fulfillment

©2018, SSR, LLC, 225 High Ridge Rd, 2nd Floor, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to BioPharmX (BPMX), Pfizer Inc (PFE), Gilead Sciences (GILD), Bristol-Myers Squibb (BMY) and Sanofi (SNY) on both securities-related and non-securities-related topics. One or more of SSR Health’s analysts owns long positions in the following stocks: ACOR, AGEN, AGIO, AKAO, ALKS, ALNY, ANAB, ARRY, BMY, DERM, DOVA, DPLO, DVA, ESALY, ESRX, FOLD, GWPH, INCY, IONS, ITCI, KALA, LOXO, LXRX, MDCO, NSTG, PFSCF, PGNX, PRTK, PTLA, RARE, RHHBY, SRPT, TBPH, TRVN, TSRO, TTPH, TXMD, VMFXX, VRTX, VSTM

  1. Medicare Payment Advisory Commission (MEDPAC); Report to the Congress, March 2018, pg. 361, Table 13-2 
  2. Higher asset utilization, greater use of physician assistants, greater use of salaried physicians as compared to physician-owners 
  3. Purchasing pharmaceuticals for less than competing retail peers (e.g. CVS, WBA) isn’t realistic given WMT’s relative scale 
  4. See MEDPAC Report to the Congress, March 2018, pg. 110, Table 4-10 
  5. AMZN: How to Enter and Dominate Pharmacy, SSR Health, November 5, 2017; AMZN: A Pharmacy Role Beyond Fulfillment, SSR Health, December 4, 2017 
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