McKesson: Theres Nothing Generic About McKesson

8/3/2019 McKesson: Theres Nothing Generic About McKesson

1/34

Theres Nothing Generic About McKessonJanuary 5, 2010


2/34

ryanf

usaro@

gmail.c

om

2

McKesson Corporation Investment Thesis

High quality, dominant drugdistribution business Prolific free cash flow generator

Predictable recurring revenue streams

Company also owns an industry leadingHealthcare IT & services unit

Both segments are benefiting fromfavorable demographic trends andhave meaningful growth potential

Intrinsic value of the business not

currently reflected in the market Significantly undervalued on a sum-of-

the-parts basis

Ticker: MCK

Stock Price: $72.33

Recent Valuation

Multiples:11.66x 11E Earnings (ex-cash)*

6.4 EV / 2011E EBITDA

Capitalization:

Equity Market

Value: $18.3bn

Enterprise

Value: $17.5bn

*Note: cash adjusted to reflect 12/30 USOncology acquisition


3/34

ryanf

usaro@

gmail.c

om

3

Company Overview

McKessons (MCK) primary business is drug distribution. MCK acts as themiddleman delivering drugs from pharmaceutical companies to users such

as pharmacies and hospitals.

MCK also operates a technology segment which sells enterprise-softwarethat helps customers including pharmacies, doctors and hospitals manageclinical data, revenue and inventory, automate processes, streamline

communications and eliminate the need for paper prescriptions and medicalrecords.

MCK has over 175 years of operating history and is ranked #14 on theForbes 500 list with over $100bn in revenues.


4/34

ryanf

usaro@

gmail.c

om

4

McKessons Two Businesses

MCK operates in two business segments

McKesson DistributionSolutions (MDS)

McKesson Technology

Solutions (MTS)

Distributes pharmaceuticalsand health and beautyproducts to retail pharmacies

and institutional providerslike hospitals and healthsystems

Provides software,automation, services andconsulting to hospitals,

physician offices, imagingcenters, home health careagencies and payors

~97% Revenues ~3% Revenues

~1.5-2% EBIT Margins ~10-12% EBIT Margins


5/34

ryanf

usaro@

gmail.c

om

5

McKessons Two Businesses (contd)

Market leader in oligopoly industry Top 3 players ~90% of revs; MCK

35%

Multiple secular tailwinds driving

growth High barriers to entry and huge moat

due to economies of scale andirreplicable network

Recession resistant business

Low regulatory exposure Limited inventory risk

Low margin, low multiple business

Strong market position infragmented industry

Stimulus spending and digitization ofhealth records driving growth

Sticky customer base and strongcustomer captivity due to highswitching costs and niche targetmarkets

Products used by 50% of hospitalsand 70% of those with over 200 beds

High margin, high multiple business

At current levels, the market is not giving any credit to the value of MCKs HealthCare IT (HCIT) unit despite it contributing 15-20% of MCKs net income. Analysts

and investors tend to value MCK based on its consolidated earnings rather than

valuing each of its two business separately, which leads to drastic mispricing.

In order to realize and unlock the intrinsic value of the business, managementshould consider spinning off MCKs technology segment, MTS

Positive Factors McKesson Technology Solutions (MTS)McKesson Distribution Solutions (MDS)


6/34

ryanf

usaro@

gmail.c

om

6

But first, a little more about McKesson


7/34

ryanf

usaro@

gmail.c

om

7

Prudent Capital Deployment

Over time, MCKs management team has proven themselves to be good allocators of

capital by using the companys substantial free cash flow to increase dividends and

share buybacks and execute accretive acquisitions

Source: MCK Company Presentation


8/34

ryanf

usaro@

gmail.c

om

8

Prudent Capital Deployment (contd)

Given its ability to generate significant cash flow, MCK should continue to be able to

conduct substantial share repurchases over time

MCK recently increased its buyback program by $1bn, raising the total authorized sharerepurchase amount to ~$1.53bn or roughly 8.5% of its current shares outstanding

Source: MCK Company Presentation


9/34

ryanf

usaro@

gmail.c

om

9

High Returns on Equity

With its low fixed-cost structure, McKesson generates high returns on equity

0%2%

4%

6%

8%

10%12%

14%

16%

18%

20%

2010 2009 2008 2007 2006

Return on Equity

Source: McKesson 10K


10/34

ryanf

usaro@

gmail.c

om

10

Strong Free Cash Flow Generation

MCKs depreciation and amortization expense typically exceeds capital expenditures,

leading to FCF per share that far greater than GAAP EPS

$(1.00)

$-

$1.00

$2.00

$3.00

$4.00

$5.00

$6.00

$7.00

$8.00

$9.00

FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010

FCFPS EPS

Source: Bloomberg


11/34

ryanf

usaro@

gmail.c

om

11

Strong Balance Sheet

MCK has over $2.5bn of cash(1), a modest net cash position, ample interest coverage (~11x) and

a staggered debt maturity schedule

0

100

200

300

400

500

600

2012 2013 2014 2017 2019 2027

Debt Maturities(in millions)

Source: McKesson 10K

(1) cash adjusted to reflect 12/30 US Oncology acquisition


12/34

ryanf

usaro@

gmail.c

om

12

New Business Model

Whereas in the past the company operated as more of areseller of drugs, MCK and other drug distributors have beenmoving to a fee-for-service (FFS) model under which it ispaid by manufacturers to distribute their drugs in exchange

for a fee.

MCKs business model is shifting towards one that allows for more stable, predictablerevenues, less inventory risk and lessens the extent to which MCKs profits aresubject to swings in the prices of drugs


13/34

ryanf

usaro@

gm

ail.c

om

13

Secular tailwinds


14/34

ryanf

usaro@

gm

ail.c

om

14

Favorable Demographics and Govt Policy Driving Demand

Massive amount of upcoming drug patent expirations, leading

to a surge in the availability of generic drugs which carry

higher profit margins

Pharmaceutical consumption and utilization on the rise due to

expansion of healthcare coverage and aging of baby boomers Government policy and stimulus programs to drive revenue

growth in MCKs technology segment

MCKs two businesses should benefit from a number of secular tailwinds as well as

increases in government spending


15/34

ryanf

usaro@

gm

ail.c

om

15

Favorable Demographics and Govt Policy Driving Demand (contd)

McKesson earns a higher profit margin on generic versus branded drugs by a factor of3-5x(1). Given the upcoming patent expiration cliff, MCK is poised to benefit from a

shift to generics as over $100bn in brand name drugs come off patent

Source: Goldman Sachs

(1) According to company estimates


16/34

ryanf

usaro@

gm

ail.c

om

16


Total pharmaceutical consumption should increase as healthcare reform enablesmillions of people to receive health insurance for the first time which will serve as a

further boon to McKessons distribution business

Source: Goldman Sachs


17/34

ryanf

usaro@

gm

ail.c

om

17


Persons aged 65 and over, the largest consumers of pharmaceutical drugs, arecurrently and projected to be the fastest growing segment of the US population for

years to come...

Source: US Census


18/34

ryanfus

aro@

gm

ail.c

om

18


and will continue to grow as a proportion of the US population

Source: US Census

24.11%

9.85%

26.80%

26.21%

13.03%

2010 US population

composition by age

segment

Under 18 years 18 to 24 years

25 to 44 years 45 to 64 years

65 years and over

23.41%

8.92%

25.88%

23.59%

18.20%

Projected 2025 US

population composition by

age segment



65 years and over

22.42%

8.67%

24.98%

22.80%

21.13%

Projected 2050 US

population compositionby age segment



65 years and over


19/34

ryanfus

aro@

gm

ail.c

om

19


The number of persons aged 65 and older is growing by millions every year

Source: US Census


20/34

ryanfus

aro@

gm

ail.c

om

20


which should give rise to an increase in pharmaceutical utilization and further drivegrowth for MCK

Source: SIG


21/34

ryanfus

aro@

gm

ail.c

om

21


A component of the Feb. 2009 $787bn American Recovery and Reinvestment Act (ARRA)called the HITECH act provides approximately $19bn in incentives to physicians and hospitals

for the implementation of Electronic Health Records (EHR). This coincides with Obama

Adminstrations goal of having EHR for every American by 2015. Payments will begin in 2011.

Qualification for stimulus money is subject to meaningful use rules and tests

MCK is working with clients to ensure they have the right resources to qualify for thestimulus money

20% of the 500,000 non-hospital physicians in the US currently have EHR in place; according

to CBO estimates, by 2014 this number will be 85% and 90% in 2019 in light of ARRA

10% of the 5,100 hospitals in the US currently have EHR in place; according to CBO estimates,

this figure will grow to 55% by 2014 and 70% by 2019 in light of ARRA

MCKs IT segment is likely to be one of the main beneficiaries of this

incremental stimulus spending


22/34

ryanfus

aro@

gm

ail.c

om

22

So what is the company worth?


23/34

ryanfus

aro@

gm

ail.c

om

23

McKesson Distribution Solutions (MDS) Peer Analysis

Data based on 1/5/11 closing prices

McKesson Cardinal Health Amerisourcebergen Median

Market Cap (mm) $18,304 $13,568 $9,523 $11,421Enterprise Value $17,533 $12,995 $9,208 $10,977

2010E Sales $110,016 $98,274 $78,536 $88,405

P / 2010E EPS 16.04 16.41 15.81 16.11

P / 2011E EPS 13.62 14.84 14.12 14.48

P / 2012E EPS 12.43 13.50 12.72 13.11


24/34

ryanfus

aro@

gm

ail.c

om

24

McKesson Technology Solutions (MTS) Peer Analysis

Cerner Allscripts Quality Systems Athenahealth Computer Programs & Systems Median

Market Cap (mm) $7,825.0 $3,749 $2,044 $1,429 $501 $2,044

Enterprise Value $7,379 $4,135 $1,938 $1,341 $486 $1,938

2010E Sales $1,853 $1,249 $332 $244 $150 $332

P / 2010E EPS 32.35 27.20 37.16 74.45 32.88 32.88

P / 2011E EPS 26.83 22.88 27.69 55.59 29.87 27.69

P / 2012E EPS 22.38 19.54 22.85 40.87 22.08 22.38

Data based on 1/5/11 closing prices


25/34

ryanfusa

ro@gm

ail.c

om

25

Sum-Of-The-Parts Analysis

Currently, the market is ascribing zero value to MCKs IT business. Said differently, at todaysprice levels you are buying MCKs high quality distribution business at an attractive price and

effectively getting its high-margin, high multiple technology business for free

Refer to notes on final slide for assumptions used

Based on the

implied value of

the MDS

segment, MCKs

current stock

price only

reflects the value

of its distribution

business

Distribution Technology

Solutions SolutionsCY 2011 CY 2011

Operating Profit(1)

$1,864 $355

Interest Expense(2)

147 28

Pre-Tax Income $1,717 $327

Income Tax(3)

566.6 107.9

Net Income $1,150.4 $219.1

Shares Outstanding(4)

232 232

EPS $4.96 $0.94

Estimated P/E Multiple(5)

Low High*

Distribution Solutions 14.12 14.84

Technology Solutions 22.9 29.9

Implied Value Per Share Low High

Distribution Solutions $70.01 $73.58

Technology Solutions $21.61 $28.21

Combined $91.62 $101.79

Current Price: $72.33% Upside 26.7% 40.7%

*Athenahealth P/E excluded as outlier


26/34

ryanfusa

ro@gm

ail.c

om

26

Note: Current Weakness in MTS Segment Masks Potential

For the first half of FY 2011, the MTS segment has seen a(temporary) decline in operating profits by ~64% due toincreased investment, a one-time non-cash impairmentcharge and revenue recognition delays.

Management expects a strong second half of FY11 for MTS asinvestment slows, certain development issues are resolvedand implementation schedules come online

Consequently, investors are being overly pessimistic aboutthe health and profitability of the MTS segment, allowing fora more attractive entry point


27/34

ryanfusa

ro@gm

ail.c

om

27

Spin-off rationale


28/34

ryanfusa

ro@gm

ail.c

om

28

Spin-off Rationale

MTS products are already deeply penetrated and thus there are few if any

remaining synergies between the two businesses

Cross-selling opportunities still exist but given the level of penetration MTS hasachieved, they have grown less important MCK can choose to spin out the majority of MTS while retaining a stub holding in the spun-off entity to

continue to build and grow the business while still unlocking its value for shareholders

The two businesses have very different growth and margin profiles and thus

deserve vastly different earnings multiples. As a result, in its current form, the

market has a difficult time assigning fair value to MCK

Give shareholders a choice whether to hold the low-margin distribution business ,

the high-margin IT business or both

Highlight the intrinsic value of the business

The MTS business is the byproduct of a merger between HBO & Co. and MCK in 1999 and its subsequent

build-out both organically and through a series of acquisitions

As a standalone entity, MTS would become 2nd largest publicly traded HCIT company by market cap (1)

(1) Based on peer multiples and estimated earnings


29/34

ryanfusa

ro@gm

ail.c

om

29

The Transaction Is Not Without Precedence

In order to re-focus on its core distribution business,McKesson competitor Cardinal Health (CAH) spun off itsnon-core tech assets in August 2009 into a separate entity,CareFusion (CFN), on a 1:2 basis

At the time, Cardinal Health retained a 19% equity stake inCareFusion

CareFusion is comprised of what was formerly Cardinal

Healths high-margin, high growth clinical and medicalproducts businesses

When taking into account the CareFusion shares received as a result of the spin-off and theappreciation of both Cardinal Health and CareFusion since the spin-off, investors that owned

CAH as of the record date of August 25th

, 2009 have earned a return of 49.5% versus a returnon the S&P 500 of 24% over the same period


30/34

ryanfusa

ro@gm

ail.c

om

30

Risk factors


31/34

ryanfusa

ro@gm

ail.c

om

31

Risks

Disintermediation

Loss of key customer(s)

Top 10 customers comprise ~52% of revenues

CVS ~15%, Rite-Aid 12%

Contract turnover is fairly rare in the industry

In light its financial condition, investors can protect against Rite-Aid bankruptcy risk by owning RAD

CDS and/or shorting its common equity

Pharmaceutical companies may decide to distribute drugs entirely themselves

Distribution business models are efficient and make economic sense

Distributors in all industries allow their respective clients to focus on their own core

competencies

MCK and other drug distributors are akin to off-balance sheet financing and help businesses

keep their cost structure down


32/34

ryanfusa

ro@gm

ail.c

om

32

Conclusion


33/34

ryanfusa

ro@gm

ail.c

om

33

Conclusion

High quality business with strong competitive position,

recurring revenue streams and multiple secular tailwinds

Attractive valuation on a consolidated basis

Trading at a significant discount to fair value on a sum-of-the-parts basis

Spin-off opportunity presents catalyst to realize value

Shares do not currently reflect value of highly profitable IT segment

Upside potential: 27-41%


34/34

ryanfusa

ro@gm

ail.c

om

34

Assumptions used

CY2011 operating profit is based on consensus estimates and allocates84% to the MDS segment and 16% to the MTS segment based onhistorical precedent

Interest expense is computed based on historical interest cost and isallocated 84% to the MDS segment and 16% to the MTS segment;

conservative estimate as MCK has been paying down debt The tax rate is assumed to be 33% based on historical precedent and

management guidance

Share outstanding is based on the assumption that the full $1.53bn sharebuyback program is exercised, resulting in a share count reduction of

21mm shares Earnings multiples are for CY11 are based on those of the comparables

listed in the peer slides, with the exception of Athenahealth which wasexcluded as an outlier

Date post:	06-Apr-2018
Category:	Documents
Upload:	ryanfusaro
View:	229 times
Download:	0 times

McKesson: Theres Nothing Generic About McKesson

Documents