Sunday, July 31, 2011

ESRX-MHS Part 2: mail facility speculations (...or: Indulging my Inner SWAGer)

Summary


  • ESRX was running at close to maximum capacity at its mail facilities while MHS has room to spare.

  • ESRX is facing a scenario of significantly increased demand as greater mail penetration is achieved in the Wellpoint book and lacked the capacity to meet this demand. Similarly, ESRX would not be able to meet increased demand from reform coverage expansion.

  • By combining, ESRX avoided having to build a new facility and the combined entity appears to have enough capacity to close at least one older mail facility. Given that a new facility can cost $140M or more, not having to build one is a nice synergy.

  • On the other hand, ESRX-MHS could also close several facilities and still build a new facility – but now amortizing the CapEx over a larger company. Also a nice synergy.

Baseline MHS

MHS appears operating its mail facilities at 65-70% capacity before the FEP and UNH losses, 54-55% capacity utilization after these losses. Here’s how that estimate was derived:





MHS has three main mail facilities – Las Vegas, Willingsboro and Whitetown. Across the three facilities, capacity appears to be ~150M Rx a year. (Note: public data on capacity varies in its recency, so there is some chance that recent unreported improvements have increased the capacity)

In 2010, MHS filled 109.8M Rx by mail order. PBMs often use smaller sites to fulfill some portion of mail order volume. Assuming 10% done outside, 99M Rx were filled in the three main facilities, implying a capacity utilization of 65-66%. Clearly, the MHS management either likes to have a significant amount of spare capacity on hand (and no doubt optimized by managing shifts) either because of prospects for Rx growth or other utilization (e.g. mail only deals like the MHS-HIP contract) – something like 35% or 50M Rx capacity available.

Per public reports, FEP was 9.8M scripts. MHS also let it be known that UNH is less than 10% of operating margin. Since mail is a key profitability driver, I hypothesize that UNH represents a comparable share of the mail volume (9.5% of 109.8M Rx = 10.4M Rx). By the way, assuming UNH commercial book is about 12M lives with an average of 12 Rx a year (implies 15% mail penetration – typical of less mail hungry plans which This would imply the 109.8M in 2010 would be closer to 80.6M Rx volume in the main facilities for a 54-55% capacity utilization.

In response to the contract losses, it appears MHS could have decided to close the oldest Las Vegas facility (with some history of labor trouble) and taken its capacity utilization up to 85-90% - quite a bit higher than MHS seems historically comfortable.

Baseline ESRX

ESRX appears to be operating its mail facilities at 90-95% capacity (quite a bit “hotter” than MHS but that’s George Paz for you). Here’s how that estimate was derived:
ESRX has two main mail facilities – Tempe and St. Louis. As with MHS, public data on the capacity of the older facility is limited but we estimate that, combined the two facilities have ~49M Rx a year.

In 2010, ESRX filled an estimated 51M conventional Rxs (note: ESRX includes specialty Rx in its mail order estimate including I believe specialty fulfilled for non-ESRX lives. The volume of the specialty was estimated using 2009 data – when ESRX last reported these separately—and derived out of the mail volume assuming specialty is typically a 30 day script vs. the usual 90 day script for mail order). Assuming a similar proportion of mail Rxs are fulfilled outside the main ESRX facilities, this would imply 46M Rx filled in the two main facilities for a 90-95% capacity utilization or about 3M Rx free capacity.

It is important to note that ESRX mail volumes increased with the WLP acquisition but the overall penetration rate has dropped from 2009’s 25% or 2010’s 20%. This is because WLP had relatively low mail penetration (estimated at 15%). The acquisition occurred late enough in 2009 that the benefit designs for WLP plans could probably not be adjusted substantially to push mail; in addition, the recession hit hard and members may have been unable to pay out 2 co-pays for a 90 day mail order script vs. 1 copay for a 30 day retail script. This will change.

ESRX-MHS future

Bringing together the five facilities implies a total mail capacity for ESRX-MHS of 200M Rx a year. Right now, the combined company has pro forma mail Rx volume of 127M a year for an overall capacity utilization of 60-65% (factoring in MHS’ FEP and UNH losses).

Demand will not stay static, of course. Two demand drivers to consider:


Wellpoint: If ESRX can bring the Wellpoint book up to its previous benchmark mark penetration of 25%, this would add another 12M Rx to the combined entity’s mail order volume.

Reform: coverage expansion in 2014 will add ~10-15% to covered lives. Assuming the combined ESRX-MHS achieves its fair share of these lives and demand patterns look similar to the current average, reform will add another 16M Rxs to mail order volume.



ESRX existing facilities would have been overwhelmed trying to meet Wellpoint incremental or Reform demand. Combined with MHS, however, these demand increases can be addressed at a very comfortable 75-80%.

In fact, there may well be room to retire one of the older facilities. Potential candidates would be:

Las Vegas (legacy MHS) which started operations in 1996 and has some history of labor trouble.


Tempe (Legacy ESRX) which began in 2003 and appears to have the smallest capacity (as least per public reports).


Willingsboro (legacy MHS) which is MHS’s original 6 football field sized super facility but was started in 2001 and may be looking a big elderly vs. the other facilities.

Considering the demand scenarios and assuming ESRX management is fine with a 10% free capacity, either Tempe or Las Vegas could be closed but probably not both and certainly not Willingsboro. Plans to close both Las Vegas and Tempe would suggest ESRX-MHS does not expect much of a tailwind from reform (as the remaining facilities would need to operate at 100% capacity) or that they are going to be building a new facility somewhere pretty quickly.

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Based on a work at blog.reconstrategy.com.