Big Win for Medco

It beats rival Caremark to a key federal contract.
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Medco

(MHS)

, the nation's largest pure-play pharmacy benefit manager, has stolen a prized contract away from the newly combined

CVS/Caremark

(CVS) - Get Report

.

Medco will now manage the lucrative mail-order pharmacy business for the Federal Employees Program. The company -- which lost the contract to Caremark a few years ago -- announced the big win on Wednesday, less than three months after CVS and Caremark joined forces in a controversial merger.

Medco can expect a $2 billion boost to annual revenues as a result of the new high-margin business. Meanwhile, CVS/Caremark will continue to manage FEP's retail pharmacy claims -- as it has for 14 years -- after renewing that $4 billion portion of the contract.

Medco jumped 4.3% to $80.40 on the news. CVS/Caremark posted smaller gains, climbing 1.7% to $37.87.

"While CVS/Caremark management was publicly confident that it would retain all of the FEP business, we believe there was some investor expectation that the FEP business might be separated, resulting in the loss of business for CVS/Caremark," William Blair analyst Mark Miller wrote on Thursday. "While it would be premature to view this as a definitive client appraisal on the competitiveness of the new company, we do believe that many analysts and investors are too sanguine about the inherent risks in a vertically oriented, merger-of-equals combination."

Thus, Miller added, "we maintain our market-perform rating" on CVS/Caremark's stock.

Certainly, SunTrust Robinson Humphrey analyst David Magee seemed less concerned by the development. Indeed, Magee suspected that CVS/Caremark itself felt there was a "decent chance" it might lose some of the FEP contract and had prepared its financial outlook accordingly. He, for one, sees no real hit to CVS/Caremark's earnings -- or threat to the company's new strategy -- and continues to recommend the stock as a result.

Magee's firm has investment banking ties to the company.

But Cowen analyst Kemp Dolliver seemed surprised by this week's news. Dolliver, like many, had expected CVS/Caremark to retain the entire FEP contract instead.

"Splitting contracts is unusual," Dolliver wrote on Thursday. "Employers typically use a single vendor in order to drive mail penetration and lower total costs.

Still, based on our discussions with benefits consultants, we do not expect other employers to mimic FEP's move."

For his part, Dolliver favors a PBM that won none of the FEP business at all. He points to

Express Scripts

(ESRX)

-- which almost spoiled the CVS/Caremark merger -- as the best investment in the group.

Dolliver believes that Express Scripts could outperform the market by 10% to 15% over the course of the next year. His firm makes a market in the company's securities.

Meanwhile, SIG Susquehanna analyst Constantine Davides is touting Medco -- especially after the FEP news -- instead.

"This represents a considerable win for Medco and leverages its industry-leading mail-order scale and robust specialty franchise," wrote Davides, whose firm seeks to do business with the companies it covers. "We continue to view Medco as the best-in-class PBM platform and believe that a forceful secular environment (generics, specialty and mail) should support growth across the PBM group" both this year and next.