CVS Caremark (CVS) recently announced that it has won a three-year contract to provide integrated pharmacy benefit services for the Blue Cross and Blue Shield Government-wide Service Benefit Plan or Federal Employee Program (FEP).

Earlier, Medco Health Solutions (MHS) served this solution to Blue Cross and Blue Shield. The new contract will be effective from January 2012. CVS expects the FEP contract to bolster its Pharmacy Benefit Management (PBM) segment, which has been under pressure over the past few quarters.  

On the other hand, loss of the FEP contract is a big blow to Medco’s PBM business as it generated nearly $3 billion in annual revenues (including approximately 9.8 million mail order prescriptions) or about 4.5% of the company’s total sales in 2010. Further, contribution of the contract to the company’s 2011 earnings guidance is around 10%.  Share prices of Medco dipped 9% on Friday, May 27, 2011, following the loss of the FEP contract. However, Medco believes that loss will not have any impact on its fiscal 2011 results.

Since 1993, CVS has been serving the retail PBM program including network contracting and management of a complete set of highly-customized clinical programs of FEP. Under this new contract, the company will also provide mail order pharmacy services and specialty pharmacy services to more than 5 million federal employees, retirees and dependents covered under FEP.

After delivering sluggish performance in past several quarters, CVS’ PBM segment posted revenues of $14 billion, reflecting an 18.4% year over year increase during the first quarter of fiscal 2011. The significant upside in revenues was primarily attributable to the 12-year contract with Aetna (AET), under which CVS provides PBM services to Aetna customers. Given the new deal with a high-valued client like FEP, we expect CVS to mark substantial improvement in this segment.

Moreover, the recent acquisition of the Medicare Part D business is a good move by the company to boost its PBM segment further. We also believe the healthcare reform will open up a big opportunity for the company. We believe all these key strategies will bode well with CVS’s future PBM growth. We are currently maintaining our Neutral recommendation on the stock.

 
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