AMZN & OMI: Two Birds, One Stone?

Richard
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SEE END OF THIS REPORT FOR IMPORTANT DISCLOSURES

Richard Evans / Scott Hinds

203.901.1631 /.1632

revans@ / shinds@ssrllc.com

@SSRHealth

November 19, 2018

AMZN & OMI: Two Birds, One Stone?

  • If AMZN enters US pharmacy, as we believe they will, the firm must handle the logistics of moving pallet / case level amounts of prescription drugs from manufacturers’ shipping docks, to the points at which AMZN fills prescriptions
  • Very large pharmacy operations typically do this through wholly owned distribution centers, where medium to smaller operations rely on drug wholesalers. AMZN could plainly build its own internal network, though this would be inefficiently utilized until AMZN pharmacies were operating at considerable scale
  • The big 3 (ABC, CAH, MCK) drug wholesalers all have major strategic alliances with large pharmacy operators (WBA, CVS, WMT, respectively) who certainly see AMZN’s entry as a threat. Because of this, AMZN may have difficulty working with any of the big 3
  • For obvious logistical reasons we assume AMZN locates its mail-order pharmacies at or near its existing fulfillment locations. If this is correct, then using location data for all US holders of the requisite pharmaceutical logistics licenses, we can identify entities other than the big 3 that might be able to meet AMZN’s manufacturer to pharmacy logistics needs
  • To set a benchmark, we calculated the percentage of AMZN’s fulfillment locations that are in the same zip code, or within a close by zip code, of any of the big 3 wholesalers, and/or a logistics network built using any of the big 3 as an ‘anchor’. For ABC, CAH, and MCK respectively, the latter (‘anchored’ network) percentages are 67.2 percent, 81.9 percent, and 72.4 percent respectively
  • We found that Medline (private) and OMI also are holders of the requisite distribution licenses, and that a Medline or OMI-anchored distribution network ‘covers’ 79.3 percent or 73.3 percent of AMZN fulfillment locations, respectively
  • This implies that, at least with respect to geography, either Medline or OMI could meet AMZN’s prescription wholesale needs as well as the big 3 wholesalers. At the very least, AMZN might make use of either company’s distribution network in an arm’s length service relationship
  • Or, a closer alliance, up to and including acquisition, might allow AMZN to both cover its pharmaceutical logistics needs, and facilitate entry into the market for distribution of consumables to US hospitals and clinics

If AMZN makes a full-scale entry into US pharmacy – as we believe they ultimately will – they face the basic challenge of moving pallet / case level amounts of prescription drugs from manufacturers’ shipping docks to the points at which AMZN fills individual patients’ prescriptions. Very large pharmacy operators (e.g. CVS, WBA, WMT) typically will have their own distribution centers that support their own retail outlets; medium and smaller sized pharmacy operators will rely on traditional drug wholesalers (e.g. ABC, CAH, MCK)

AMZN could, and very likely may, build out its own pallet / case level Rx storage and distribution network. Or, at least in the earlier stages of an entry into US pharmacy, AMZN might choose to rely on a wholesale drug distributor (WDD) and/or third-party logistics provider (3PLs)

One major difficulty with using a traditional wholesaler is the simple fact that the only wholesalers (ABC, CAH, MCK) large enough to meet AMZN’s needs are in tight strategic relationships with pharmacy operators (WBA, CVS, and WMT, respectively) who are plainly threatened by a potential AMZN entry

To get a sense of whether AMZN has a viable alternative to a traditional wholesaler, other than immediately building out its own pallet / case level distribution network, we mapped the locations of registered WDD’s and 3PL’s against the locations of AMZN’s fulfillment centers[1]. We consider an AMZN fulfillment location to be ‘covered’ by a WDD or 3PL location if that WDD or 3PL location was either in the same zip code as the AMZN fulfillment location, or falls within one of the 5 closest zip codes containing any WDD or 3PL location. To establish a benchmark, we identified the percentage of AMZN fulfillment locations covered by each of the big 3 drug wholesalers, and the percentage of AMZN fulfillment locations that could be covered by the most efficient combination of a big 3 wholesaler, paired with other vendors. CAH, MCK, and ABC each ‘cover’ 40.5 percent, 31.9 percent, and 24.1 percent of AMZN fulfillment locations respectively. If we add other providers of warehousing and logistical support as efficiently as possible to each ‘anchor’ wholesaler, we find that the CAH anchored network ‘covers’ 81.9 percent of AMZN’s fulfillment locations, as compared to 72.4 percent and 67.2 percent for MCK and ABC anchored networks, respectively (Exhibits 1a – 1c)

As it turns out, there are two operators of licensed WDD / 3PL facilities who, at least theoretically, can ‘cover’ AMZN’s fulfillment locations as efficiently as a big 3 wholesaler – Medline, and Owens & Minor (OMI). Medline’s locations cover 36.2 percent of AMZN locations, as compared to 26.7 percent for OMI; and, an optimal network built using Medline as an anchor covers 79.3 percent of AMZN’s facilities, as compared to 73.3 percent for OMI (Exhibits 2a, 2b)

Medline and OMI both are distributors of consumables to various care settings such as hospitals, outpatient facilities, nursing homes, etc. Much of their consumables lines are non-pharmaceutical, though both companies include pharmaceuticals in their product offerings, and hold the requisite WDD and 3PL registrations. Medline (private) claims $10.2B in annual sales; trailing 12m global revenues for OMI are $9.7B, of which +/-$8.9B came from the company’s US distribution operations

Either Medline or OMI could offer AMZN pallet / case level distribution capabilities that are at least geographically comparable to those that might have been available from the big 3 wholesalers, in a relationship that is anything from arm’s length to full acquisition

As a private company Medline’s strategic circumstances are challenging to determine. OMI’s share price recently has been cut nearly in half over the last month, as the company cut its dividend, lowered full-year guidance, and declined to offer guidance for 2019

We note that Amazon’s B2B service (Amazon Business) recently (April 2018) shelved its efforts to enter hospital pharmacy, and believe that an OMI acquisition might serve both as a means by which AMZN can enter hospital supply (both pharmaceuticals and other consumables), and as a logistics platform that supports AMZN’s entry into prescription dispensing

At Friday’s close, OMI carried an enterprise value of $2.35B, $1.82B of which is net debt. OMI’s US distribution operations encompass 7M square feet of warehousing space which – assuming $65/square foot in build costs and a building: land square footage ratio of 1: 1.5 – would cost more than $500M to reproduce[2]

A partnership with, or acquisition of OMI is certainly not AMZN’s only option for handling the pallet / case level logistics associated with an entry into US pharmacy; however, on balance OMI does appear to be a relatively cost-effective way of both handling that logistical task, and providing the company with a firmer foundation for entering the US hospital supply market

 

 

  1. Implicit in this exercise is our belief that AMZN’s pharmacies will be co-located with – or at least very close by – AMZN’s existing fulfillment centers. We believe that AMZN pharmacies would need separate ingress / egress, HVAC, and security from non-pharmaceutical fulfillment operations, and that pharmacy packages and non-pharmacy packages can be integrated into the same package ‘stream’ once pharmacy packages are closed and labelled for shipment ↑
  2. Assuming land costs of $250,000 / acre 

 

©2018, SSR, LLC, 225 High Ridge Rd, 2nd Floor, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to BioPharmX (BPMX), Bristol-Myers Squibb (BMY), Celgene (CELG), Gilead Sciences (GILD), GlaxoSmithKline (GSK), Johnson & Johnson (JNJ), Merck (MRK), Pfizer Inc (PFE), Sanofi (SNY) on both securities-related and non-securities-related topics. One or more of SSR Health’s analysts owns long positions in the following stocks: ADMA, AERI, ALXN, ARDX, BMY, CRSP, CSSPF, DPLO, EDIT, HRTX, IMMU, ITCI, LXRX, MDCO, NTLA, OMI, REPH, RHHBY, SAGE, SGMO, SRPT, STML, VRTX

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