October 18, 2010 HEALTH SERVICES (DRUGS WHOLESALE) Henry Fund ResearchMedcoHealth Solutions (MHS) Investment Recommendation BUYJared Plotz, Healthcare Analyst Current Price $firstname.lastname@example.org Target Price Range $64-68 INVESTMENT THESIS MedcoHealth Solutions provides clinically-driven pharmacy services designed to improve the quality of care and lower total healthcare costs for its clients and their members. The company has maintained impressive revenue and earnings growth over the last 7 years and we recommend acquiring the company below $58, for the following reasons: (+) Generic drug utilization has and will continue to grow as additional brand name drugs come off patent in future years, physicians’ willingness to prescribe generics increases, and patients’ desire for lower cost generic drugs increases. (+) International expansion in Europe using Medco’s services model, will increase sales while increasing margins. Service margins garner 7+% gross marginsSource: http://yahoo.investor.reuters.com compared to 5.5% product gross margins. Medco is expanding into 29 countries through a 50-50 jointKey Stock Statistics venture with Celesio.52-Week Price Range $43.45-66.94 (+) Mail-order drugs are gaining acceptance, especiallyMarket Capitalization (B) $23.1 among patients with chronic conditions. Chronic orShares Outstanding (M) 433.6 complex diseases affect 50% of the US population. 96% of drug costs treat these conditions. PoorInstitutional Ownership 79.3% management of chronic and complex diseases can60-Month Beta 0.76 lead to $350 billion of excess total healthcare costs. i Mail-order will decrease costs and raise compliance.Dividend Yield 0.0%Price/Earnings (ttm) 18.8 (+) Medco’s gross, operating and profit margins are below competitor Express Scripts, meaning there isPrice/Book 4.73 plenty of room to grow. Revenue is now growing fasterPrice/Sales 0.37 than SG&A (9.9% versus 1.5% in 2Q2010), which should result it operating margin expansion.ROA (ttm) 8.7%ROE(ttm) 25.6% (+) The acquisition of Accredo Health in 2005 has seen 20% plus CAGR in revenues and operating income andProjected 5-Year Growth 16.9% maintains a gross margin above 7%.EPS ($) (-) Healthcare reform has eliminated the RetirementYear 2007 2008 2009 2010E 2011E 2012E Drug Subsidy (RDS) tax advantage and could causeEPS clients to drop coverage. 1.66 2.17 2.66 3.14 3.72 4.30 All earnings represent earnings from operations and have been filtered (-) Competitors are starting to undercut prices to steal from net nonrecurring gains. market share. This could cause price erosion inValuation Models management fees.Discounted Cash Flow $70.31 (-) Express Scripts acquired WellPoint’s pharmacy $70.31 benefit management business and will now have theEconomic Profit scale needed to effectively compete with Medco.Relative P/E $45.89 (-) Walgreens is starting to offer 90 day prescriptions inDividend Discount Model $68.61 its pharmacy stores, which will cut into the competitive advantage that Medco’s online pharmacies provide. Important disclosures appear on the last page of this report.
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of ManagementEXECUTIVE SUMMARYMedcoHealth Solutions is a Fortune 50 company that wasspun off from Merck in March 2003 and has maintained a20% CAGR in earnings per share over the following 7 years.It is the largest of the 3 big pharmacy benefit managers(PBMs) by drug spending and has over 65 million members.While Medco’s competitors have maintained short short-termoutlooks and have undercut Medco prices in recent years togain market share, they have fallen behind significantly in Source: Medco 2009 Annual Reporttheir value proposition. Not only has Medco continued todrive growth and profits like its competitors, but at the same In 2007, Medco acquired Liberty Medical Supply, Inc. to taptime, Medco has invested heavily in growth drivers for 2014 avily into the growing diabetes care services market. Diabetesand beyond. Medco is now well positioned to succeed long patients represent 8% of the US population and account for iiiafter the current generic growth wave slows in 4 years. 4-5 15 percent of overall drug spending.We have initiated a Buy recommendation with a 12 month ave The company currently has international exposure in Sweden,price target of $64-68 for Medco’s stock, representing 20-27% Germany, and the UK, and will soon be expanding to Italy, ny,upside over Medco’s current trading price. We believe in the France, and Spain. The company’s new joint venture withgrowth strategies that Medco is pursuing and believe that it Celesio will eventually expand service to all of the EU27has the ability to drive out its competitors and possibly rive member nations, Norway, and Sweden.consolidate the industry in years to come. The company wasnot significantly negatively impacted during the recession andshould experience positive growth regardless of the economic ess RECENT DEVELOPMENTSenvironment going forward. Earnings Report In the second quarter of 2010, Medco reported record EPS ofCOMPANY DESCRIPTION $0.77 versus $0.64 in the same quarter last year, reflecting anMedco is a pharmacy benefit management services company increase of 20.3%. Diluted EPS was $0.83, also a 20.3%that provides prescription drug benefit programs designed to increase. Net revenues for the quarter were $16.4 billion, amoderate the cost and enhance the quality of pharmacy 9.9% increase over last year.health care. The company has secured more than $5 billion in net net-new“Medco’s products and services include benefit design and sales in 2010 and has completed roughly 95% of the 2010 Medco’smanagement, pharmacy network management, clinical planned renewals as of July 22. The company still maintainsmanagement, specialty pharmacy solutions, diabetes a 99%+ client retention rate which is driven by the company’smanagement, home healthcare products and Medicare high customer satisfaction rate. Competitor Express Scriptsspecialists and client services. It offers a w ices. wide spectrum of has completed more than half of its 2011 client renewals, butbenefit design options for appropriately sharing costs between is only experiencing a 95% client retention rate, indicating haringplan sponsors and enrollees, and provides proper incentives inferior service quality or value proposition compared tofor encouraging preferential use of more cost cost-effective Medco.treatments (OTC and generics) and pharmacies (In (In-network The company has also secured $1.0 billion in 2011 net y net-new iiretail, mail-order, and special care).” sales, and completed roughly 45% of its scheduled 2011The company operates nine PBM mail-order facilities and six renewals as of July 22. The company’s generic dispensing ordercall center pharmacies. Medco’s Therapeutic Resource rate was 70.6% in the quarter up from 67.3% in the sameCenters meet the complex needs of people with chronic quarter last year. Adjusted prescripti prescription volumes were upmedical conditions including diabetes, cancer, heart disease, 6.0% and its mail-order penetration declined 0.1%. orderand asthma. Medco employs more than 1,000 speci specialty The increased use of generics in 2Q2010 translates intopharmacists in these centers. record savings to clients and member of approximately $870 membersProduct revenues contributed 98.5% of revenues in 2009, million, as well as increasing average margins for Medco.while service revenues contributed the other 1.5%. Of The earnings report was not spectacular, given that they still eproduct revenues, 62% are sold through retail pharmacies, have significant pressure to fill their 2011 book in the next two ues,while 38% are sold via Medco’s mail-order pharmacies quarters, but it was not bad either. The fact that their order pharmacies.Competitor Express Scripts sells 65% of prescriptions through retention rate has not declined indicates that a large portion ofretail, and 35% through mail order. A further breakdown of their long-term contract renewals will come in the 2nd half ofrevenues is attached to this report. the year.Medco is the nation’s largest purchaser of generic drugs. Share RepurchasesMedco’s primary wholesaler, AmericsourceBergen Corp.accounted for approximately 62% of overall 2009 drug Medco completed its prior $3 billion stock repurchasepurchases. The rest of drug purchases come directly from program in the quarter, and has repurchased $696.5 million ofpharmaceutical manufacturers. the company’s new $3 billion repurchase program started in May 2010. The company purchased more than anticipated 010. 2
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of Managementstock in the quarter due to the lower share prices. In 1Q2010, Generics have driven Medco’s leading industry drug trend,the company repurchased at an average stock price of drug trend being decreasing drug costs. Below is Medco’s$45.38. In 2Q2010, the company repurchased at an average revenues and dispensing rate for generic drugs over the last 5stock price of $58.14. After the company finishes its latest years:buyback program, it will have repurchased 23% ofoutstanding shares over 3 years.Margins and CashGross margin declined in the quarter due to client renewalpricing, higher retail volumes, and a decline in the Accredosubsidiary’s gross margin, partially offset by generic growthand a litigation settlement. Gross margin for the second halfof the year should be slightly higher than 6.7% and shouldaverage 6.7% for the FY2010.Cash on the balance sheet has declined because of stockrepurchases. Cash flow from operations has declined due tosignificant inventory reduction and strong retail claim volumegrowth in 2009. rdWhile we may see a soft 3 quarter due to seasonality in the v MedcoHealth Solutions 2009 Annual Reportbusiness, we expect a strong finish to 2010 with recordEBITDA and operating margin improvement of 8 basis points. Revenues continued to maintain their healthy climb during the economic recession, partly due to a rise in the genericThe company has revised its FY2010 EPS guidance upwards dispensing rate (which garner higher margins for Medco), andto $3.10-3.15/share, from $3.05-3.10/share previously. Our $17 billion in net new revenue in the last 3 years.model forecasts earnings of $3.14/share in 2010.Healthcare Reform This rise in generic dispensing rate will continue in the next 4-Healthcare reform does not significantly hurt Medco’s 5 years as additional brand name drugs come off patent asbusiness operations. The expanded coverage of 30 million demonstrated in the chart below. This trend will enableadditional Americans will provide increased demand (volume) generic dispensing rates to continue to climb, as well asfor Medco’s services. Additionally President Obama’s push Medco’s margins, due to higher rates on generics.for low-cost healthcare and efficient healthcare solutions willprove beneficial to Medco’s positioning strategy.In the Medicare space, the newly enacted reform strippedaway the tax advantage of the Retiree Drug Subsidy (RDS),which could cause some clients to drop or limit retireeprescription drug coverage. However 1/3 of current RDSclients are tax-exempt entities, therefore only 2/3 are at risk ofdropping coverage.INDUSTRY TRENDS“PBMs emerged in the 1980s, primarily to provide cost-effective drug distribution and claims processing for thehealthcare industry. The PBM industry further evolved inresponse to the significant escalation of healthcare costs inthe 1990s, as benefit plan sponsors sought to moreaggressively contain costs. PBMs developed strategies to vieffectively influence both supply and demand. MedcoHealth Solutions BMO Capital Market Presentations MaterialsOn the supply side, PBMs leverage their buying power (size Medco is on the forefront of industry innovation, distancingof networks) to negotiate purchase discounts and rebates itself from its competitors and positioning itself as a completefrom manufacturers, and discounts from distributors and retail solution for its clients’ members’ needs. The company is thepharmacies. leading specialty pharmacy and mail-order pharmacy in the world. It is also a leader in clinical innovation, leveraging itsOn the demand side, PBMs educate clients, members and therapeutic resource centers and research in drug-to-drugphysicians on cost-effective prescription medications and and drug-to-OTC interactions.apply various techniques to encourage members to makecost-effective choices, such as the use of less expensivegeneric drugs and the more efficient mail-order channel. The company is best-in-class and will continue to define theGeneric substitution for drugs on which patents have expired industry and be the leader in industry innovation goingis a significant and growing factor in reducing costs.” iv forward. 3
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of Management Medco is on par with the Select Average in price, but fallsMARKETS AND COMPETITION short of the average in operating and profit margins. WeThere are three main competitors in the PBM space: Medco, believe this will change as Medco increasingly leverages itsExpress Scripts, and CVS Caremark. Express Scripts services business, which maintains 7+% gross marginspurchased WellPoint’s PBM business to become roughly the compared to roughly 5.5% for its product business.same size as Medco. Medco and Express Scripts both ateinto CVS’s market share in the last few years, but CVS looks ECONOMIC OUTLOOKto take back some of what it lost, in the 2011 selling season. The economic outlook for the US is neutral due to highIn addition to competing with the other two big PBMs, Medco unemployment, decreased per capita wealth resulting fromcompetes with a wide variety of market participants, including continued trouble in the housing market, and high federal andregional and local PBMs, Blue Cross/Blue Shield plans, state budget deficits.insurance companies, managed care organizations, largeretail pharmacy chains, large retail stores and supermarkets While the healthcare industry traditionally remains stable inwith in-store pharmacy operations and Internet pharmacies. times of economic distress, which was seen at the bottom inIts main competitors are Aetna Inc., CIGNA Corporation, CVS March 2009, the industry has lagged the overall sidewaysCaremark Corporation, Express Scripts Inc., Humana Inc., market since the beginning of 2010.UnitedHealth Group, Walgreen Co., and Wal-Mart Stores Inc. The passage of President Obama’s healthcare plan liftedMedco competes primarily in designing and administering some uncertainty in the sector, but has also resulted inprograms and services that provide flexible and high quality increasing costs to companies.prescription drug benefit management to clients and members Outlined below is a list of economic drivers that have an effectat competitive pricing to the plan sponsor. on the healthcare industry:Medco believes that its commitment to differentiating itself Unemploymentfrom its competitors will drive success after the generic wave US Change in NonFarm Employment & Unemployment Rate Launc h full data releasepasses. Its competitors do not have an international 600 (DI FF 1M) All Emplo yees, T housands Total Nonf arm SA - United Stat es (Left) Unemployment Rate - Percent , Sa - United Stat es (Left) Unemployment Rate - Percent , SA - Unit ed St ates (Right) Recession Periods - United Stat es 11%presence, an online store and personal drug management 400 10%system, or real-time drug-to-drug and drug-to-OTC safety 200checks, among other competitive advantages. 9% 0 8%Below are tables of operating and valuation statistics for -200 7%Medco’s competitors, as well as a table comparing Medco to -400a select industry average. -600 6% 5% -800 Company Market Cap (B) Revenue (B) P/E (ttm) P/E (fye) -1,000 4% Aetna 12.81 34.65 8.71 9.65 10/ 07 1/ 08 4/ 08 7/ 08 10/ 08 1/ 09 4/ 09 7/ 09 10/09 1/ 10 4/ 10 7/ 10 CIGNA 9.64 19.71 7.95 7.73 viii 42.44 98.23 11.99 10.38 Source: FactSet Economic Chartbook CVS Caremark Express Scripts 26.20 36.26 27.57 15.28 Unemployment has declined slightly from its high of 10.1% in Humana 8.61 32.44 7.50 8.89 October 2009, but has steadily remained above 9.5% over the UnitedHealth 38.62 89.94 9.24 9.76 last 62+ weeks. A slight increase of 0.1% month over month Walgreen 32.66 67.42 16.05 11.76 in August indicates that high unemployment is showing no Wal-Mart 197.86 416.66 13.97 12.39 signs of abating. Henry Fund consensus estimate is for Company P/S P/B Op. Margin Profit Margin unemployment to stay at approximately 9.4% for the next 6 Aetna 0.37 1.24 7.30% 4.46% months and in the 8-9% range for the next 2 years. High CIGNA 0.49 1.62 10.29% 6.27% unemployment is bad for all aspects of consumer spending, CVS Caremark 0.44 1.21 6.49% 3.73% including healthcare. However it increases the need for cost Express Scripts 0.72 7.20 5.08% 2.68% reduction practices and services provided by Medco. Humana 0.26 1.30 5.94% 3.55% GDP Growth UnitedHealth 0.43 1.54 7.97% 4.77% Gross Domestic Produc t, Real %Chg P /P - United States Walgreen 0.48 2.26 5.13% 3.10% 6 Wal-Mart 0.47 3.07 6.08% 3.54% 4vii 2The highlighted competitors above are used in the SelectAverage below. 0 -2 Industry Average Industry Median Select Average Medco Market Cap 46.11 29.43 33.77 22.82 -4 Revenue 99.41 51.84 67.30 62.76 -6 P/E (ttm) 12.87 10.62 18.54 18.56 P/E (fye) 10.73 10.07 12.47 13.39 -8 7/07 10/07 1/08 4/08 7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10 P/S 0.46 0.46 0.55 0.36 P/B 2.43 1.58 3.56 4.72 Source: FactSet Economic Chartbook Op. Margin 6.79% 6.29% 5.57% 3.75% Profit Margin 4.01% 3.64% 3.17% 2.16% 4
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of ManagementReal GDP growth, a barometer for the health of the economy management fees to gain market share. This could hurt theand the deciding indicator of expansion or contraction, has PBM space going forward.declined from its peak at 5.00% Y-o-Y growth in December US Dollar2009. In June 2010, growth stood at 1.6%, and we see2H2010 growth of 1.5%. This is bad news for the general Trad e W eigh ted U S$ v s. Maj or Curren cies Nominal Trade-W eighted Exchange Rate Index, Major Currenc ies, 3/1973=100 - United Statesmarket as the speed of the recovery is slowing and fears of 95 Real Trade-Weighted Exchange Rate Index, Major Currenc ies, 3/1973=100 - United States Recess ion Periods - United States 95slipping back into negative growth are still present. Thesefears could cause customers to once again cut back 90 90expenditures, increasing drug non-compliance. 85 85Consumer Spending/Confidence 80 80 Real Personal Cons umption Expenditures, Bil. Chained 2005 $, Saar - United S tates 9,400 75 75 9,350 70 70 9,300 65 65 10/07 1/08 4/08 7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10 10/10 9,250 Source: FactSet Economic Chartbook 9,200 The US dollar has fallen from its highs in March 2009. As 9,150 international investors braced for the worse, money poured into the US dollar, considered the safest currency and government bonds available. But as the recovery has 9,100 10/07 1/08 4/08 7/08 10/08 1/09 4/09 7/09 10/09 1/10 4/10 7/10 gathered steam and US stimulus activities have widened theSource: FactSet Economic Chartbook national debt, investors have slowly left the dollar. We seeConsumer spending has thus far seen a V-shaped recovery. the dollar remaining weak for the next 2 years. In a weakAfter bottoming in April of 2009, the US consumer has dollar environment, multinational companies based in the USaggressively purchased goods. This purchasing is partly due benefit the most. At the same time, domestic companies alsoto federal stimulus, including President Obama’s Cash for fare well. Multinationals can trade their foreign sales for moreClunkers automobile program and his First-time Home Buyer US dollars, while domestic companies see an increase inCredit. Both of these programs have ended, and yet exports, due to increased demand for the now cheaperspending has not seen the fall that some experts predicted. goods.This will be a key indicator to watch going forward. Any signs Both of these aspects should help Medco, especially inof a decrease in spending could indicate more trouble to relation to their competitors. Medco’s new joint venture withfollow, but may actually increase the use of generic drugs, a Celesio should provide favorable currency exchange profits.key Medco strategy. Forward estimates of the direction of the dollar are unreliableInflation and so we will have to wait and see. Housing US Existing H ome Sales Launch full data release %Chg Y r A go Millions of Units 50% 7.5 (% 1Y R) Exis ting Home Sales , Housing Units, S AAR - United S tates (Left) Exis ting Home Sales , Hous ing Units, SAAR - United States / 1000000 (Right) Recess ion Periods - United States 40% 7.0 30% 6.5 20% 6.0 10% 5.5 0% 5.0 -10% 4.5 -20% 4.0 3.83 -25.49Source: FactSet Economic Chartbook -30% 01 02 0 3 0 4 05 06 07 08 0 9 10 3.5Inflation has been very tame throughout the last year. Source: FactSet Economic ChartbookInflation has established itself in the 2% range for most of2010. Fears of deflation have yet to be founded and runaway After showing a strong recovery in late 2009, 2010 has seen ainflation has yet to be seen. severely sharp decline in the housing market. Not only do housing prices continue to fall, but existing home sales andAs of now, it appears that inflation in the 1.5-2.5% range new home sales continue to fall as well, and foreclosure ratesshould be expected going forward. This has no significant hit an all-time decade high in August 2010. The stimuluseffect on Medco’s operations. In terms of industry pricing, the effects of the First-time Home Buyer Credit have elapsed andhealthcare sector has seen vast differences. Drug pricing has subsequently the housing market has fallen.been declining. Medco is part of this decline as they push fordrug trend. At the same time as some of Medco’s The housing market is showing few signs of turning aroundcompetitors, such as CVS Caremark, have been cutting and many economists see further declines. While this economic driver doesn’t directly affect Medco’s business 5
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of Managementlines, the housing market affects almost all aspects of the increasing steadily around 300 basis points per year andeconomy indirectly. Until a sustained turnaround in the Medco earns a higher margin on generics.housing market is seen, we expect GDP, consumer spending,and investor confidence to continue crawling sideways. This Generics sales grew 12% in 2Q2010 and the dispensingmeans that demand for drug trend (cost reductions) will rate grew 330 basis points. Generics likewise encourageincrease and subsequently demand for Medco’s services. compliance among patients by decreasing drug costs. Specialty Pharmacy: Accredo has seen tremendous success over the last 5 years. It is a key in profitability forCATALYSTS FOR GROWTH the company (contributing $450 million to net income in 2010) and in its breadth of services (making Medco all-Current Drivers encompassing). Clients like using Accredo and have Financial Strategy: Medco has squeezed significant cash incentives to use Accredo. Not only is Accredo’s care out of the balance sheet, is increasing ROIC, and can pay superior to competitors, but it is also cheaper. interest payments 15 times with current cash. Future Drivers New Business: A lot of high retail Medicare business; $1.0 MedcoHealth Store: Medco’s online store provides a billion in net new sales for 2011 and 45% of renewals virtual channel for patients to purchase non-prescription already completed. Retention rate above 99%. products, with the ability to utilize mail delivery while Mail-Order: Medco is the largest mail-order pharmacy in utilizing Medco’s safety analysis in interactions between the world. They already have two distribution facilities in prescription drugs and OTC drugs, vitamins, and xiii Las Vegas and New Jersey, and are opening a third in supplements. Indianapolis this year. Each facility is capable of filling 1 International: In addition to the previous strategies in million prescriptions/week, meaning they now have Germany and the UK, Medco is in Sweden and is soon to capacity to fill 156 million prescriptions/year. be in 29 different countries in Europe through its 50-50 Mail-order will revolutionize the drug distribution for joint venture with Celesio. In Sweden, Medco transformed chronic conditions. 50% of the US population has chronic its software to Swedish, converted drug metrics, and has and complex diseases. 96% of drug costs treat these licensed its software to the Swedish government to wire conditions. ix 75% of medical expenses in the US are drug retail in the country. x spent on chronic conditions. And for 88% of chronic and Europe has price controls, and so Medco’s joint venture st xi complex diseases, drugs are the 1 choice. will focus on its service model. Medco’s service model Mail-order will significantly decrease the costs for patients currently maintained gross margins of 7+%, and so any with these chronic conditions. This will help close the expansion in service revenues will greatly expand the gaps in non-compliance. There are up to 50% non- company’s overall margins. compliance rates after one-year of therapy in many Europe is interested in technology enabled clinical disease categories. Costs are a major contributor to this capabilities that they currently don’t have. Medco will since these drugs cost patients thousands of dollars a improve the quality of care and lower overall healthcare year. This will save healthcare billions of dollars. costs for payors through the joint venture. The 29 As compliance rates increase, costs per user decrease, as countries have a combined GDP greater than that of the shown in the following chart: US. ePrescribing: Medco is transforming what the web experience means to a consumer. In the future, Medco plans on putting applications on the iPhone and Verizon’s Blackberry that will allow for e-prescriptions. This will transform what a patient and a physician do in the office. Clinical Innovations: Through 15 Medco Therapeutic Resource Centers, customers can interact with Medco specialist pharmacists in their exact disease condition. If a patient receives a warning that two drugs they are planning on taking or have been prescribed should not be taken together or should be watched more closely, the patient will get a warning message and ask the patient if they would like a phone call to discuss. If the patient enters their phone number, a pharmacist that specializes xii MedcoHealth Solutions BMO Capital Market Presentations Materials in the patients’ precise conditions will call within 60 seconds and give real-time advice to the patient. Generics: Generics have a strong pipeline of drugs coming off patent in the next 5 years, especially in 2012. Comparable Effectiveness: In 2009, the company Medco encourages plan members to utilize generic drugs. established the Medco Research Institute, which will There has been an increase in physicians’ willingness to coordinate, extend, and amplify their internal genomics prescribe and patients’ willingness to take and keep taking research initiatives and increase collaborations with generic drugs. Generic dispensing rates at Medco are 6
THE UNIVERSITY OF IOWAHenry Fund Research Henry B. Tippie School of ManagementEarnings per share are expected to grow 14-17% per yearover the next 5 years. ROIC is assumed to be roughly 34% in REFERENCES2010 and 35% on a continuing basis after 2015, reflecting thecash-flow rich nature of the PBM industry and the relatively i MedcoHealth Solutions 2Q2010 Conference Call and BMOlow need for ongoing capital investment once significant scale Capital Markets Conference, slide 13is attained. ii Life Science Analytics, Company Profile: MHS, SeptemberWe currently rate the stock a Buy with 20-27% upside over 13, 2010, Business description taken from MedTRACKthe next 12 months. If larger managed-care customers, such iii MedcoHealth Solutions Company Websiteas UnitedHealth decide to bring PBM services in-house, we iv MedcoHealth Solutions 2009 Form 10-K, Industrywould revise our estimates downward by 20% and the stock Overview, page 4would be fairly priced in the $53-56 range. However, we don’t v MedcoHealth Solutions 2009 Annual Report, page 7expect this to happen as WellPoint’s decision to exit the PBM vi MedcoHealth Solutions, Presentation Materials for BMOspace with its sale of its PBM business to Express Scriptsdemonstrates the acknowledgement of the value-proposition vii Capital Markets Conference, slide 7that the integrated PBM’s provide. Yahoo Finance, Key Statistics for each competitor viii FactSet Economic ChartbookIf customer-retention slides below 98% or if Medco fails to fill ix Medco Researchits 2011 scheduled client renewals book, we would revisit our x Center for Disease ControlDCF model and accompanying assumptions and possibly xichange our recommendation. Likewise, if Medco’s non-core xii Medco Researchstrategies (including its Therapeutic Resource Centers, mail- MedcoHealth Solutions BMO Capital Marketorder delivery, and specialty pharmacy) fail to be met by Presentations Materials, slide 15 xiiicustomer demand, we may change our recommendation to MedcoHealth Solutions 2009 From 10-K, Industryreflect the wasted capital expenditures in these areas. Overview, page 5 xiv MedcoHealth Solutions 2009 Annual Report, page 4 xv Morningstar Report by Matthew Cofina and KarenIMPORTANT DISCLAIMER Anderson, September 15, 2010This report was created by a student(s) enrolled in the AppliedSecurities Management (Henry Fund) program at the University ofIowa’s Tippie School of Management. The intent of these reports isto provide potential employers and other interested parties anexample of the analytical skills, investment knowledge, andcommunication abilities of Henry Fund students. Henry Fundanalysts are not registered investment advisors, brokers or officiallylicensed financial professionals. The investment opinion contained inthis report does not represent an offer or solicitation to buy or sell anyof the aforementioned securities. Unless otherwise noted, facts andfigures included in this report are from publicly available sources. Thisreport is not a complete compilation of data, and its accuracy is notguaranteed. From time to time, the University of Iowa, its faculty,staff, students, or the Henry Fund may hold a financial interest in thecompanies mentioned in this report. 8