Amazon's effect on healthcare: disruption & deal-making?

At the end of October, it emerged that Amazon was approved for wholesale pharmacy licenses for at least 12 states, immediately wiping out billions from stocks of the major players in the pharmaceutical supply chain. How could Amazon’s healthcare move look like and what is the industry’s response?

The new player in the pharmaceutical supply chain

The rumours about Amazon entering the US healthcare market have been circulating for more than six months. The company has already started to sell professional medical supplies, with prescription drugs seen as the next move. News about obtaining the wholesale pharmacy licence added further downward pressure to the already battered share price of the giants in the pharma supply chain. Amazon denied that this was a move to sell drugs online and clarified that “wholesale licences are required to sell professional-use only products to healthcare customers, from medical and dental offices to hospitals.” Wholesale activity is exactly what is now speculated to be the first push into prescription drugs. Although wholesale pharma market yields thin margins in comparison to retail, it is still greater than the current margin for Amazon. Moreover, in wholesale, Amazon could utilize its massive warehouse capacity (with some costs to adapt them to the standards required to store drugs) as well as its logistics experience. Such development would pose a direct competitor to McKesson or Cardinal Health, major pharma wholesale distributors. However, it is interesting to consider how Amazon’s move into retail would look. It would have the option either to sell drugs online and thus collect prescriptions by mail or operate through brick-and-mortar pharmacies in its Whole Foods stores. According to Ian Read, Pfizer’s CEO, Amazon’s move lies in the interest of the industry and consumers as it could potentially cut costs on distribution and increase the availability of products to patients. The main question is whether Amazon will set up its own PBM (Pharmacy Benefit Manager), which controls master lists of reimbursable drugs and generally has a huge influence on what the patients ends up taking. There is much discussion over this issue, as some people believe that it would be impossible to decrease the aggregate cost of drugs for patients without prescribing cheaper alternatives (e.g. biosimilars). On the other hand, Ian Read considered it a difficult proposal as Amazon will then have an influence on whether patients could access specific drugs.

The largest insurance deal for underway

On the next day after the news about Amazon move into healthcare gripped the industry, the potential tie-up of CVS Health and Aetna emerged. CVS is one the biggest US pharmacy retailers, which might make it unclear why it wants to spend more than $60bn on the third largest health insurer in the US. Timing of the talks and its possible strategic implications are regarded as the direct response of the industry to the disruption caused by Amazon. The proposed combination would be the biggest deal for an insurance company and would create one of the most powerful companies in the prescription drug industry.

According to the Wall Street Journal, CVS has proposed more than $200 per Aetna share (with pre-event stock price at $160.1), thus valuing the insurer at $66bn. It is around 11.0x EV/EBITDA and 1.1x EV/Sales. On the news arrival, Aetna’s share price rose more than 12%.

Considering the strategic implication of such deal, it is necessary to examine what the new company would entail. There are already some insurers operating an integrated model with PBM, enabling them to strike favourable deals with drug-makers. However, combining health insurer with PBM and the chain of nearly 10,000 pharmacies (the biggest in the US) would stand out as the first combination of this type and scale as well as the one in which the retailer has a dominant position. Such powerful group could have greater leverage in negotiating prices with pharma companies, which could positively impact customers, driving drugs prices down. Following the merger, Aetna’s members will be in a convenient position as they could access CVS stores and possibly obtain some discounts. Moreover, the vertically integrated company, would have greater competitiveness in its healthcare offering and could potentially offset the entry of Amazon.

However, it is unknown how the regulators would consider such deal. Historically, healthcare transactions usually lead to higher prices for consumers, which in the current conditions would pose a significant threat. Furthermore, lately DoJ blocked Aetna’s proposed takeover of Humana on the grounds of that it would harm consumers and reduce competition. On the other hand, it could be possible for both CVS and Aetna to present a deal as beneficial for the consumer because of the above-mentioned reasons such as lower drugs prices or greater medication accessibility.

According to the FT, CVS is advised by Evercore and Barclays, and on the sale side, Aetna is working with Lazard.