The Long Road Back
McKesson has more than recovered from an ill-fated
acquisition. But its shares have not.
By Jaye Scholl
The stock market doesn't seem to know what to do with McKesson.
Three-and-a-half years ago, when the 168-year-old drug distributor
announced a deal to acquire HBO & Co., then a leader in medical
information systems, McKesson's shares soared to an all-time high of 96.25,
more than double their price just a year earlier.
Six months later, however, HBO was revealed to be a swamp of fraudulent
accounting and shady deals. In the largest one-day loss ever recorded on
Wall Street at the time, the company's shares plummeted 47%, from 65 a
share to 34, vaporizing $9 billion in shareholder wealth. McKesson ultimately
had to restate downward, by $191 million, three years of HBO's earnings.
And the company's shares, recently at 37, have never recovered.
Wall Street may be missing the story again. While the $14 billion in stock that
McKesson paid for HBO is mostly money down the rabbit hole now, what
remains of the acquired firm, now known as McKesson Information
Solutions, is not totally without value, as the market would have you believe.
What's more, McKesson's basic drug distribution business is thriving. In fiscal
2002, McKesson is expected to report earnings around $430 million, or
$1.46 a share, on revenues of $50 billion. That's up from a loss of $48.3
million and well above the company's peak of $304.6 million, or $1.10 a
share, in 1998. According to FirstCall, analysts are predicting earnings of
$1.80 a share in fiscal 2003, a 23% increase. McKesson's shares trade at 20
times the '03 estimate.
Over the past five years, McKesson has more than tripled revenues, from
$15.7 million in 1997, mainly through acquisition. Yet McKesson trades at a
mere 0.19 times sales, a steep discount to the 0.61 for close rival Cardinal
Health.
Most of McKesson's earnings are
coming from drug distribution. Last
year, overall pharmaceutical sales
in North America rose 16%, according to IMS Health, which monitors them.
Sales over the next few years are expected to remain in that range, what with
three million of the 76 million Baby Boomers turning 60 -- the age when
serious illness begins to set in -- each year, and as more drug therapies
become an alternative to surgery.
But McKesson Information Solutions, which will post revenues of $1 billion in
fiscal 2002, should earn at least $50 million in operating profits this year, up
from $1 million last year. And McKesson Chief Executive John Hammergren
clearly thinks the opportunities for the business are wide open.
"I think it's possible to become the Microsoft of health care," Hammergren
told Barron's in an interview at the company's San Francisco headquarters.
He also thinks McKesson has the inside track. "When the hospital's c-suite
[corporate suite] thinks of an information technology solution, McKesson is
the only company that can provide all of its answers."
Plenty of people -- competitors, clients, industry pundits -- would disagree
with Hammergren's heady assessment of his company. But the company is
earning high marks in the industry for stabilizing the division over the past two
years. In a recent survey of the top 20 healthcare information technology
vendors by KLAS Enterprises, an independent agency that conducts
confidential interviews with buyers of medical technology, McKesson was
named "most improved." No question there was, in the wake of the scandal, a
lot to improve upon. But obviously, there has been significant progress.
There is plenty of progress yet to be made, not just for McKesson, but for the
industry as a whole. More than 25 years after health-care outfits began
computerizing their operations, medical-information systems have been poor
relations to their wealthy corporate cousins. Forget about systems that can
maintain a person's medical records from cradle to grave, electronically
transmit lab results or X-rays to doctors at their offices and homes or provide
a link from a patient's hospital bed to a databank of best-care practices.
Hospitals still take months to produce a single comprehensive medical bill
after a patient's stay.
The problem is that hospitals typically spend just 3% of their operating
revenue on information technology, compared with 5% for manufacturers and
10% for banks. Your ATM card can access dollars in California or euros in
France, but the surgery schedule for a hospital's operating room still is
circulated on paper.
Indeed, most hospital computer systems, which were initially introduced to
solve problems such as accounting and billing, are obsolete. And as various
departments added their own systems for admissions, radiology, laboratory,
emergency-room and pharmacy services, they created an electronic Tower of
Babel, with none of the systems capable of speaking to one another. The
solutions range from starting over from scratch with a single supplier to
building a "best of breed" system to upgrading the legacy software.
While hospitals mull over their strategies, powerful outside forces are pushing
hospitals to pursue technological solutions to some of their more intractable
problems, in particular, the alarming number of medical errors. According to
he Institute of Medicine's 1999 report, To Err is Human, at least 45,000
deaths occurred every year because of avoidable medical mistakes.
The IOM's disturbing findings sparked the creation of the Leapfrog Group, a
coalition of some of the country's biggest employers, including General
Electric, General Motors, AT&T, IBM and Boeing. Leapfrog quickly
identified three areas that can improve patient safety in hospitals: allowing only
physicians with extensive experience perform certain medical procedures --
employ specialists in intensive care units and required use of computer
physician order entry, or CPOE. Leapfrog companies, which collectively pay
15% of the health-insurance bill in the U.S., warned that they would direct
their 28 million employees and their families only to hospitals with CPOE.
Currently only 3% of the 5,500 U.S. hospitals use CPOE, and the Leapfrog
mandate has sent the rest on a buying spree. Last July, McKesson formed a
partnership with Vanderbilt University Medical Center to build a CPOE
systems. Scheduled for release in July, it's billed as the jewel in the crown of
McKesson's new Horizon Clinicals, an array of integrated systems.
Another technology push is coming from the Health Insurance Portability and
Accountability Act of 1996. HIPAA is a health reform package that
germinated in the Clinton Administration and contains two big
technology-related regulations.
One requires health-care providers to use a common electronic language for
transmitting data instead of the 400 formats now in use. It seeks to end the
confusion that arises, for example, when "congestive heart failure," is
sometimes spelled out, sometimes abbreviated as "chf" or sometimes simply
assigned a code number.
On top of that, health-care providers are reeling from the latest evidence,
based on the past 18 months, that reveal a sharp increase in health care use
among people ages 40 to 54 years. Between body scans, plastic surgery and
new knees, Baby Boomers are visiting their doctors and scheduling surgery at
three times the historical use rate.
McKesson, of course, is not alone in chasing this potentially huge market.
Large enterprise software companies, including Oracle, SAP and PeopleSoft,
have their eye on the industry. General Electric, an on-again, off-again
participant, is back and has recently bought a score of health-care information
companies. And Siemens, the big German conglomerate, entered the medical
IT field in May 2000 with the acquisition of Shared Medical Systems.
A handful of specialists in medical-information management systems are also
competing. They include Cerner, Eclipsys, IDX Systems. No one company
has more than a sliver of this highly fragmented business. Based on 2000
revenues, Siemens had the largest market share, with 4.9%, followed by
McKesson, with 4.8% and Cerner with 2.1%. The market share of the six
biggest players amounts to only 15.9%. This year, the industry as a whole is
expected bring in $23 billion.
McKesson has the largest installed base, and while much of it is rickety with
age, its has the appeal of the familiar. More important, McKesson has the
deep pockets and, apparently, the commitment, to fund the R&D required to
bring forth the next generation of medical information technology -- Horizon
Clinicals. This suite of applications has been getting traction over the past
year.
Pill-pusher
In its core drug-distribution business, McKesson acts as a middle man, buying
medicine from the pharmaceutical manufacturers and reselling it to big retailers
like Rite-Aid, Wal-Mart and Costco, as well as to independent pharmacies,
hospitals, clinics and HMOs. In a good year, this business earns a ho-hum
3% profit on revenues. But demand is growing, and margins could get a bump
from the increasing number of drugs that are coming off patent. When generic
drugs are available from more than one manufacturer, distributors can garner
deep discounts by throwing all of their business to a single firm.
McKesson's major rivals in drug distribution are AmeriSourceBergen and
Cardinal Health. McKesson was shocked from its complacency a decade ago
as upstart Cardinal started grabbing market share. Since then, Cardinal and
AmeriSourceBergen have increased their clout by gobbling up competitors.
Based on trailing 12-month revenues, Cardinal Health now ranks No. 1 in the
industry, followed closely by McKesson. AmeriSource and Bergen combined
last year to become a strong No. 3.
Hammergren cheerfully predicts that McKesson's distribution business can
grow within its existing customer base. By way of example, he cites
Wal-Mart's recent pick of McKesson to repackage the drugs for retail sale.
As Hammergren told analysts, McKesson "can continue to perform very
nicely without having to take major share from our competitors."
Having blundered badly three years ago, McKesson, once a Wall Street
darling, now can't seem to find a friend. But given it strong core business and
the opportunities that lie ahead in information technology, investors may find
the shares quite amiable in the years ahead. |
