Combined Company Will Grow Shareholder Value and Transform Healthcare In an Increasingly Demanding Healthcare Environment
[icahn]
Q2 hedge fund letters, conference, scoops etc
BLOOMFIELD, Conn.–(BUSINESS WIRE)–Cigna Corporation (NYSE: CI) (“Cigna” or the “Company”) issued the following letter to stockholders in response to the letter released by Carl C. Icahn about the Company’s proposed merger with Express Scripts Holding Company (NASDAQ: ESRX) (“Express Scripts”).
Dear Cigna Shareholders:
Cigna strongly disagrees with Mr. Icahn, who has recently chosen to publicly object to our previously announced merger with Express Scripts. The Board recommends that Cigna shareholders vote “FOR” the combination with Express Scripts.
In the nearly five months since the merger announcement on March 8, 2018, neither Mr. Icahn nor his representatives have contacted Cigna or otherwise offered their views. Moreover, Mr. Icahn has disclosed that he only owns approximately one half of one percent of Cigna’s stock and has a “substantial” short position in Express Scripts.
Cigna believes that the proposed combination will create tremendous value for shareholders, accelerate the transformation of healthcare and address the dynamic regulatory environment for health services. Mr. Icahn, on the other hand, has made a speculative financial bet against the transaction in the hopes that he can create a gain at the expense of Cigna and Express Scripts shareholders. Mr. Icahn’s opposition is misguided and short-sighted. Moreover, the assertions in Mr. Icahn’s letter are value destructive and demonstrate a clear lack of understanding of the dynamics of the healthcare industry.
Mr. Icahn does not represent the interests of Cigna shareholders. Mr. Icahn has made clear through his recent and limited entry into Cigna stock and “substantial” short position in Express Scripts that his motives are not aligned with Cigna’s shareholders and he has no interest in creating value for shareholders (other than himself). It is not clear that Mr. Icahn even believes his own rhetoric and so-called concerns with the Express Scripts business model. In fact, nine of his businesses renewed their PBM contract with Express Scripts within the last year.
The letter demonstrates an uninformed view of the current healthcare marketplace and Cigna’s strategy. Mr. Icahn appears to believe that a multi-year partnership with an existing PBM provider would be preferable to the announced transaction. There are a number of issues with this view.
First and foremost, it demonstrates a complete lack of understanding of Cigna’s business model and how we win in the marketplace. The integrated medical, pharmacy and behavioral services model has been the cornerstone of Cigna’s long-term strategy. It allows us to improve health on the front end, thereby decreasing the need for acute medical services and lowering costs. We will not be able to inoculate ourselves from changes in the dynamic marketplace by sitting on the sidelines and hoping that others figure it out – nor would we want to. In fact, with respect to pharmacy, costs have rapidly risen from approximately 10% of the total healthcare equation to almost 25% and as such present a critical and sustained opportunity for innovation and value creation for our clients and customers.
Furthermore, the notion that we can negotiate a complex multi-year agreement with a third party that will allow us to deliver attractive PBM affordability to our clients and customers while the rest of the industry reformats itself is naïve at best. We have first-hand knowledge as a PBM operator that these arrangements are complex and that it would be exceedingly difficult to draft a static contract that benefits Cigna in all scenarios in a changing environment. This is one of the reasons why the next logical step to meaningfully accelerate our strategy and reduce healthcare costs is to expand our pharmaceutical services by fully acquiring Express Scripts.
Finally, Cigna operates in a highly regulated healthcare environment, where regulatory and competitive change is constant as demonstrated by the adoption and evolution of the ACA, the rise of the public and private exchanges, hospital systems taking on more insurance risk and employers contracting directly with hospital systems. Each of these changes brought with it a regulatory or competitive threat to the current model – whether the threat of a shrinking employer market or the threat of disintermediation of insurers. The only constant in healthcare is that unsustainable cost increases are creating disruptive changes in the environment. Cigna has sought to embrace these changes and innovate in order to find opportunities for growth in this dynamic landscape. As a result, during a period of unprecedented changes in the healthcare environment, Cigna has delivered double-digit top-line and bottom-line growth over an 8-year period, 384% cumulative total shareholder returns from December 31, 2009 through June 30, 2018 and leading U.S. total medical cost trend results (less than 3% in 2017 – representing the lowest in the industry).
Our combination with Express Scripts will give Cigna the scale to more effectively address regulatory change and drive transformation in pharmaceutical pricing that works for our model – while at the same time giving us the vast capabilities of Express Scripts to deliver superior and differentiated pharmacy services to our clients and customers in a sustainable non-disruptive fashion that allow us to compete or partner with others in the market from a position of strength. The combination also allows us to make definitive moves to tackle the underlying issues that are causing the disruptive regulatory changes – the unsustainable costs increases in healthcare. As industry leaders in cost trend management, Cigna and Express Scripts have set the strategic goal to lower medical and pharmacy trend to a level at or below Consumer-Price Index by 2021.
- “ESRX is a strategic platform acquisition for CI to drive industry leading total cost trend across medical and pharmacy, particularly with the increasing importance of Specialty Pharmacy. ESRX offers CI a combined platform at scale that can compete with the new Big 4: UNH with Optum Rx, ANTM with Ingenio Rx, and AET with CVS. The deal is not about CI’s outsourced relationship for its own membership, but as a broader imperative across all segments and geographies for Employer, Health plan and Government. Value based care discussions are now evolving from providers to outcomes based payments for drug manufacturers.”
– Ana Gupte, Leerink (3/26/18) - “We are supportive of the [Cigna and Express Scripts] deal… We do understand, respect, and buy into the concept that if you have scale on the managed care side and scale on the pharmaceutical benefit management side, that through better data analytics you can actually lower the per member per month cost by, we think, $20 or 5% per member per month and since Cigna is mostly an ASO business that’ll mostly get passed onto customers. So this merger will actually be pro-competitive and pro-customer.”
– Glenview Capital CEO Larry Robbins, a Cigna and Express Scripts investor, in a CNBC interview (4/23/18) - “Should its acquisition of ESRX close, giving CI the power of formulary management at scale for more than 25% of the US population (>80mn PBM lives for ESRX standalone, before contemplating CI’s 16mn medical members), the company could further improve its ability to manage drug trend … We believe it is also worth noting that the potential to improve CI’s ability to manage drug prices lower for >25% of the US population via its acquisition of ESRX (a proportion that we think could grow organically over time, should the deal close) by better integrating pharmacy and medical cost management is well-aligned with one of the administration’s top health policy priorities today: lowering drug costs.”
– Stephen Tanal, Goldman Sachs (6/6/18)
The letter misrepresents the potential impact of rebate regulation. Mr. Icahn’s letter ignores certain realities of the Administration’s current Drug Pricing Blueprint and its alignment with the underlying principles of our proposed transaction. Further, Mr. Icahn looks to the pharmaceutical industry – whose incentives are naturally aligned with Mr. Icahn’s views – in an attempt to lend credence to his erroneous beliefs that elimination of all rebates is imminent and will be disastrous to PBMs.
Without question the President and Secretary Azar are serious in their intent to lower prescription drug costs and to make significant changes in the health delivery system. That is an important goal that we fully support and believe that the combination can be an accelerant for positive change.
As it relates to the impact of action by HHS to eliminate or amend rebates in Medicare Part D, today 100% of rebates are passed through to help lower premiums and reduce costs for both the beneficiary and the government. If these Medicare rebates were phased out, it would not have a material impact on Express Scripts’ earnings. While potential changes to the commercial market are more complex to effectuate, Express Scripts already passes approximately 95% of all pharmaceutical purchase discounts, price reductions and rebates back to its core PBM commercial and health plan clients and their members. Express Scripts clients determine how these discounts are used or shared 100% of the time. Additionally, a successful commercial structure already exists where nearly half of Express Scripts’ clients have opted for a full, direct pass through arrangement for all rebates and this is augmented by the ongoing shift to value-based relationships for all of their services. Express Scripts is focused on meeting the challenges faced by its members and its clients, and as a result, its clients are seeing a reduction in their pharmacy bill – in the first half of 2018, Express Scripts helped its clients achieve a record low drug trend of 1.1%.
As it relates to the Administration’s Drug Pricing Blueprint, here are a few critical facts:
- The Anti-Kickback Statute is the statute that applies to rebate payments, but it only applies in federally funded health care programs. It does not apply to commercial contracts – in fact, there is no clear mechanism for the federal government to regulate commercial rebates without Congressional action.
- Concerns have been raised that any elimination of rebates in government programs would result in a rise in beneficiary and government costs because the pass-through effect of the rebate dollars would be eliminated – which could result in challenges (legal and political) of any action.
- HHS OIG issued a report late last year finding that if an inflation-based rebate were in place for Medicare Part B in 2015, it would have saved $1.4 billion or $1.8 billion on 64 high-expenditure drugs that represented 81 percent of total Part B drug expenditures that year, depending on whether the rebate was calculated based on Average Sales Price (ASP) or Average Manufacturer Price (AMP), respectively.
- In their 2018 report, the Medicare Trustees noted that in 2016, manufacturer rebates represented 19.9 percent of total prescription drug costs and rebates have continued to grow since the inception of the Part D program more than decade ago. The trustees credit these rebates as a “major reason for decreases in overall Part D costs when compared to the 2017 Trustees Report.”
- An analysis of the most recent National Health Expenditures prescription drug forecast for 2017-2026 concluded that increased rebates “contributed to lower net prices for many prescription drugs in recent years and are expected to have dampened prescription drug spending growth in 2017. In 2018 and beyond, the share of total prescription drug spending affected by rebates is not expected to increase as rapidly as in the recent past. As a result, the outlook for such spending reflects somewhat stronger growth in drug prices.”
- If HHS pursued a removal or significant modification to the safe harbor in Medicare Part D, it is unclear how quickly those changes could be implemented, and further delay could result from the expected legal challenges to the final rule.
Accordingly, we expect that any changes to Medicare Part D rebates will be manageable.
- “We believe that the ongoing shift to value-based pricing models could also lessen the reliance on rebates and better align economic incentives. While it is unclear if we will see a similar shift in the commercial market, we are seeing a shift in that market towards the use of value-based programs, which align incentives and can lower overall costs, as evidenced by ESRX’s SafeGuardRx programs and CVS Caremark’s Transform Care programs. Through these programs, PBMs have already implemented programs that seek refunds from manufacturers on behalf of their clients if drugs don’t work, guaranteeing trend or adherence levels, or setting up high-performance pharmacy networks where reimbursement is tied to outcomes.”
– Lisa Gill, JP Morgan (7/19/18) - “While we acknowledge that contracting is likely to continue to evolve over time, if rebates were to “go away” in a vacuum without some commensurate pricing change the result would be exploding costs for clients and patients (not going to happen) given the significant portion of the benefit that is passed through. In addition, we would highlight that much like CI’s clients, ESRX’s customers have funding options and almost half have chosen direct pass-through contracts on rebates. While we expect the area of contracting to evolve, we view recent concerns as overblown and view contracting tied to outcomes as an area that likely sees increased traction over time and one that we think would leave the combined CI/ESRX extremely well positioned.”
– David MacDonald, SunTrust (8/3/18) - “Regardless of what happens to rebates, PBMs provide economic value through formulary placement and aggregation of negotiating power, serving as a market check on branded drug manufacturers. We would expect them to continue to be compensated for that value through drug price negotiation reflective of their scale and positioning.”
– George Hill, RBC Capital Markets (7/19/18
The letter unduly discounts the long-term value creation of the proposed combination. Mr. Icahn’s purported “solution” for increasing value to shareholders is to have Cigna use the cash portion of the Express Scripts consideration and free cash flow to aggressively repurchase its own shares. We disagree with Mr. Icahn, and believe the combination with Express Scripts will deliver greater, sustained shareholder value.
First, Mr. Icahn’s underlying premise that Express Scripts’ business is struggling is completely false and undermined by their strong second quarter results. Express Scripts reported new business growth, sustained differentiated cost and quality results for the benefit of clients and outstanding client retention with an increased midpoint of 98% (up from 97%). Such outstanding results indicate that their clients – such as Mr. Icahn’s own nine businesses – are satisfied with the overall value that is being delivered.
The combined company will build off of the strength of Express Scripts’ capabilities and value creation in the market to accelerate Cigna’s growth strategy and deliver immediate and long-term value to our shareholders in the form of mid-teens accretion in the first full year after closing, excluding accretion from transitioning clients, and greater than $600 million in retained synergies. As a result, Cigna has raised its 2021 EPS target to $20-21 vs. prior guidance of $18. The transaction will also generate greater than $6 billion in free cash flow in 2021, allowing for immediate deleveraging and exceptional strategic and financial flexibility in a highly dynamic marketplace. We do not believe that our current stock price is a reasonable barometer of the expected performance of the combined company as expressed by a number of analysts:
- “However, if this comes to pass, we would expect CI to outperform the peers once deal closing comes into clarity as the deal has strategic merits, is financially attractive and CI is trading at a significant discount to peers.”
– Kevin Fischbeck, BAML (3/9/18) - “We see meaningful opportunity around the pending ESRX deal (ESRX, $78.39, Buy) which further integrates the crucial pharmacy benefit and should provide for deeper collaborative relationships. In addition, ESRX is posting historically low drug trend, superb customer retention and tangible cost benefits from higher penetration of its solutions. Finally, we see opportunity around clinical solutions (e.g. SafeGuardRx, TRCs), medical management (e.g. eviCore), synergies and cross-selling … We like the company’s integrated offering, attractive absolute/relative medical trends, strong cash flow and see meaningful opportunities on several fronts from the pending Express Scripts combination.”
– David MacDonald, SunTrust (6/11/18) - “Cigna trades at 12.0x our 2019E EPS, a meaningful discount to the group tied largely to what we view as underappreciated value from the pending ESRX acquisition. We view CI’s risk/reward as highly compelling tied to robust core trends, strong cash flow and what we expect to be significant benefits from ESRX.”
– David MacDonald, SunTrust (6/11/18) - “Nevertheless, the accretion from this deal is highly compelling, projected in the double-digit percentages in Year 1. Longer-term, Cigna continues to project $20-21 in EPS by 2021. This would leave the stock at just 8-9X that pro forma EPS forecast, leaving significant wiggle room for the company to fail to meet its expectations. The company’s outlook assumes merely cost synergies, but investors could be overlooking the potential upside opportunities. Cigna’s core health insurance business should be improved due to the integrated benefit offering and the opportunity to target new customers. In fact, the companies overlap in only ~30% of markets, suggesting there could be a significant opportunity to grab market share for each business … Overall, we believe the market’s pessimism about the deal would ultimately prove to be unwarranted if the deal does go through.”
– Michael Wiederhorn, Oppenheimer (6/12/18) - “ESRX immediate accretion, FCF and $20-21 in EPS by 2021E offer financial flexibility that can fuel further capital deployment in key strategic areas not possible at CI’s current size to compete with players such as UNH or threats from new technology entrants.”
– Ana Gupte, Leerink (8/3/18) - We continue to believe that many of those who retained their stake in CI after the initial deal announcement have taken a long-term view on the deal and believe in the value proposition of the combined entity to drive long-term growth.”
– Steve Valiquette, Barclays (8/7/18)
For these reasons, we believe that Mr. Icahn’s thesis is misguided and short-sighted.
Cigna’s Board and management team believe that our proposed merger with Express Scripts is in the best interest of shareholders. The market will continue to evolve due to the regulatory and competitive environment and rising healthcare costs, with pharmaceutical costs approaching 25% of total healthcare costs.
The combination broadens capabilities and distribution for more than 100 million combined customers and deepens data and insights to improve predictability and deliver better health outcomes. This will position Cigna to deliver differentiated immediate and long-term value to our shareholders in the form of strong EPS accretion, significant free cash flow generation and exceptional financial flexibility in a highly dynamic marketplace. We believe that this delivers much more substantial value than a quick financial engineering scheme for the benefit of a singular, transitional investor, who claims to own only 0.56% of Cigna’s outstanding common stock.
The Cigna management team has a proven track record of creating shareholder value in an ever changing marketplace and the Company remains committed to successfully completing the merger with Express Scripts by year-end 2018.
The Board recommends that Cigna shareholders vote “FOR” the adoption of the merger agreement with Express Scripts. Cigna will hold a Special Meeting of its Shareholders to vote on the proposed merger with Express Scripts at 9:30 a.m. local time on August 24, 2018, at The Delamar Hotel’s Ballroom, 1 Memorial Road, West Hartford, Connecticut. Cigna shareholders of record as of the close of business on July 10, 2018, will be entitled to vote at the Cigna Special Meeting.
If shareholders have questions about the transaction, or need assistance in voting shares, please contact Cigna’s proxy solicitor, Innisfree M&A Incorporated: toll-free at (877) 750-9498. Additional materials addressing the Express Scripts transaction, including more information on the strong strategic rationale and expected financial results, are available on Cigna and Express Scripts’ joint transaction website: http://www.advancinghealthcare.com.
Sincerely,
Cigna Board of Directors
About Cigna
Cigna Corporation (NYSE: CI) is a global health service company dedicated to helping people improve their health, well-being and sense of security. All products and services are provided exclusively by or through operating subsidiaries of Cigna Corporation, including Cigna Health and Life Insurance Company, Connecticut General Life Insurance Company, Life Insurance Company of North America, Cigna Life Insurance Company of New York, or their affiliates. Such products and services include an integrated suite of health services, such as medical, dental, behavioral health, pharmacy, vision, supplemental benefits, and other related products including group life, accident and disability insurance. Cigna maintains sales capability in over 30 countries and jurisdictions, and has more than 95 million customer relationships throughout the world. To learn more about Cigna®, including links to follow us on Facebook or Twitter, visit www.cigna.com. For more information about Cigna’s proposed acquisition of Express Scripts, please visit www.advancinghealthcare.com.
