Walgreens Erring on the Side of Caution Could Boost Competitors Bottom Lines

By all accounts it seems certain that the relationship between Express Scripts and Walgreens is done, and while I sympathise with Walgreen's concern that Express Scripts is undercutting them, I also believe that their decision to part ways with the company could give an edge to growing competition in the pharmacy retail sector. This edge would most notably go to rival CVS, which has been adding stores and beefing up advertising lately.

Walgreens tends to make light of the situation, saying that longer term implications if they'd have decided to accept Express Script's market proposal "would have been far worse than the short term impact on earnings." Still, Express Scripts accounts for nearly 10% of the 819 million prescriptions Walgreens fills on an annual basis. According to most analysts that will shave off about $5 billion in annual revenue from their bottom line. The question is, does that figure only account for the money they'd have earned filling the 80 million prescriptions—what about the losses from potential other retail sales which typically occur as people waiting for their prescriptions browse the aisles, and ultimately buy stuff?

I will say that I applaud Walgreens for at least standing firm in favor of their interests. While losing 10% of a big part of your business can't, in my view, ultimately be good for business, neither is sending a message to other pharmacy benefit managers that Walgreens is open to being strongarmed in order to keep customers.

A deal could still be hammered out. That's true. But the thing is that this tussle between the largest pharmacy retail operator and one of the largest pharmacy benefit managers in the U.S., whose largest client also happens to be the Department of Defense's TRICARE program gives time for Express Scripts to weigh in on how much of an impact on their business they will have without Walgreens in the picture. This time and assessment of impact could either benefit Walgreens, or Express Scripts. Other pharmacy retailers have been clamoring for a chunk of the 80 million prescriptions Walgreens won't currently fill, and CVS stands to gain at least around 20 million of those—a lucky opportunity for them as this could add around $200 million a year to their bottom line.

There is also the question of what impact a merger between Express Scripts and Medco Health Solutions might have, providing the FTC approves it? Walgreens CEO Gregory Wasson has already said that he would not do business with the combined companies.

It's really a wait and see game. Ultimately I think CVS stands to gain the most from this back and forth. Getting market share is all about getting people to switch to your product or service, and Walgreens just essentially handed 10% of their prescriptions business to their many competitors. I think Walgreens should hold its ground. But it should also be careful not to become the next Sears or Kmart when business for pharmacy retail really gets ramped up as more and more baby boomers over the next 15 years or so start getting prescribed more medications, and seek out providers to get them filled.

Even more interesting is that CVS over the last 4 quarters far outdid Walgrens producing better than 3 times the cash than Walgreens did over the same period. In fact, it took in more than $1 billion more than Walgreens did. That means CVS will have more cash to work with to fuel its store improvements, ramp up advertising, repurchase shares and increase dividend payouts to shareholders, and add stores. All feats which could further erode market share for Walgreens. To my mind, that's quite an edge that just gets better if Express Scripts and Walgreens stay on the wrong side of each other.