A government probe could be triggering serious side effects for
Formally accused of defrauding the government, Medco has found itself unable to renew a huge contract to provide mail-order pharmacy benefits to millions of federal employees. The former Merck division -- which ranks as the largest pharmacy benefits manager in the country -- recently lost the $1.7 billion megadeal to competitor
News of the loss, expected to hurt earnings this year and next, sent Medco shares plummeting 10% to $31.67 Wednesday afternoon. The setback was the latest -- and largest -- in a series to hurt the PBM.
Since 1999, as a probe of the company heated up, Medco has lost a number of Blue Cross/Blue Shield contracts, such as the one it managed for federal employees. David MacDonald, an analyst at Leerink Swann, noted the losing streak on Wednesday.
"This is the second top-10 customer ... Medco has lost in a week," MacDonald said.
Medco, too, expressed surprise.
"Medco Health was acknowledged last year in a report by the U.S. General Accounting Office with helping to provide significant savings, choice and access to millions of federal employees," stated Medco CEO David Snow. "Given their historically high satisfaction rate -- and our ability in 2002 to contain drug trend well below the national average -- we are disappointed by the decision."
Medco's latest defeat comes just three months after federal prosecutors filed a sweeping, expanded complaint accusing the company of bilking the government. James Sheehan, an assistant U.S. attorney who's suspicious of the PBM industry in general, claims that Medco has defrauded government customers by failing to properly fill their prescriptions and charging them for medicine they never received. He also insists that Medco has improperly favored expensive drugs manufactured by its former parent.
Sheehan filed full-blown charges against Medco last June -- and expanded them in December -- after investigating whistleblower complaints against the company for years. For its part, Medco has hotly maintained its innocence and pledged to "patiently, but aggressively, pursue vindication."
"After a more-than-four-year sealed investigation, capped off with numerous staged press conferences and media interviews, one would have expected the government's amended complaint to be replete with specifics pertaining to the alleged misconduct uncovered during its investigation," the company stated in a motion to dismiss filed last December. "It is, however, noteworthy only for its generality."
Regardless, the probe seems to be taking a toll. Until now, Medco has managed to renegotiate the federal contract -- two times -- since Sheehan began investigating the company. But Medco actually faced formal charges this time around.
Some on Wall Street noted a possible correlation.
"While we believe that price and service were likely major components in the decision to switch PBM providers, we also believe that the regulatory overhang may have finally had a meaningful impact on Medco," wrote Glen Santangelo, an analyst at Schwab Soundview Capital Markets who still recommends buying the stock. "This distinction may have been enough to shift the balance of power away from Medco, regardless
as to whether the allegations are true."
Credit Suisse First Boston analyst Kevin Berg suspects the probe hurt Medco's chances as well.
"We do not believe Caremark won this business on price," Berg stated. "The government, rightly or wrongly, perceived Medco as more risky, given its Sheehan legal exposure."
Berg went on celebrate the win as a big victory for Caremark. But that PBM faces challenges as well. For starters, Caremark stands accused of defrauding customers in the state of Florida. And the company's suitor,
, brings to the union fraud charges of its own.
But Banc of America analyst Robert Willoughby still points to Medco as the most pressured of the group. And he doesn't even dwell on regulatory risks. He simply raises concerns about Medco's ability to compete with some of its smaller peers.
"Management has pointed to aggressive pricing in the past as a reason for contract losses, but it's less clear to us why the entity with the deepest pockets historically has consistently been a loser with major plans," wrote Willoughby, who has a neutral rating on Medco's stock. "Assuming there is an economic reason why contracts change hands, the other independent PBMs that have grown more rapidly -- which includes just about all of them -- must be offering more in the way of savings to their customers."