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Walgreen balks, walks away from Express Scripts

A sign for a Walgreens store is seen in Belle Glade, Florida
A sign for a Walgreens store is seen in Belle Glade, Florida

By Jessica Wohl and Phil Wahba

CHICAGO/NEW YORK (Reuters) - Walgreen Co will stop filling prescriptions for people covered by drug benefits manager Express Scripts Inc at the end of 2011 after failing to agree on new contract terms, walking away from a deal worth more than $5 billion in annual sales.

Tuesday's announcement echoes a similar but short and intense battle Walgreen settled with CVS Caremark Corp's pharmacy benefit manager (PBM) unit a year ago and some suggested the largest U.S. drugstore chain was using its stature as a negotiating tactic.

"These guys are good poker players," said Smead Value Fund portfolio manager Bill Smead. "But by saying January 1, they're really allowing a lot of time to kiss and make up."

Walgreen said it would no longer be part of the Express Scripts network as of January 1, 2012, if it cannot reach a deal. Express Scripts prescriptions are expected to be worth $5.3 billion in sales for Walgreen this year, or about 7 percent of the chain's total expected revenue.

The breakup is part of long-running battle over costs in the lucrative market for prescription drugs, a market that is growing as the U.S. population ages.

"We're prepared and ready to live in a world without Express Scripts," Walgreen CEO Greg Wasson said during a conference call with analysts on Tuesday.

Express Scripts said in a statement later it was "shocked" by Walgreen's move and expressed hope the chain would return to the table.

At issue are the discounts Walgreen offers Express Scripts clients. Express Scripts said Walgreen gives its clients lower discounts than other drugstores do and wants it to accept market rates.

Express Scripts said that if Walgreen does not adjust its rates, patients would bear the brunt of the expected inflation in drugs in the coming years.

Walgreen has 7,715 drugstores across the United States, more than any other chain, giving it clout with PBMs. Express Scripts said other pharmacies near Walgreen's locations can fill the void if Walgreen does indeed leave its network.

Analysts expect the pair to reach an agreement before the end of the year, with some expecting one in weeks.

"I'm seeing it as a negotiating tactic," Standard & Poor's Equity Research analyst Joseph Agnese said of Walgreen's announcement. "There are too many benefits for both companies to not have a deal."

Walgreen shares finished the day down 4.2 percent at $43.28 after sliding to $42.18. They had hit a yearly high on Monday. Express Scripts shares ended 0.4 percent higher at $54.99.

DEJA JUNE

Tuesday's announcement was reminiscent of a stare-down Walgreen had last June with CVS Caremark. After 11 days, Walgreen and CVS -- which runs a large pharmacy benefits business, Caremark, as well as drugstores -- settled a dispute over prescription reimbursements, saving a relationship worth billions of dollars for both companies. Walgreen had been ready to stop filling prescriptions for millions of CVS Caremark drug plan members.

"This is literally a replay of the spat with CVS Caremark," said Smead, whose fund has held Walgreen shares for about three years. "Everyone is trying to squeeze blood out of turnips."

Express Scripts said it was trying to keep prescription drug costs affordable.

CVS declined to comment.

Prescriptions that Walgreen fills for Express Scripts clients account for about 7 percent of its total sales, the same amount the CVS Caremark business was worth. Walgreen also stands to lose sales from Express Scripts patients buying other merchandise when they come in to pick up prescriptions.

Overall, prescription sales make up nearly two-thirds of Walgreen's revenue.

PROFIT RISES

Also on Tuesday, Walgreen said profit rose to $603 million, or 65 cents per share, in its fiscal third quarter that ended on May 31, from $463 million, or 47 cents per share, a year earlier. The profit, which was helped by a lower tax rate, topped analysts' forecast by 2 cents per share, according to Thomson Reuters I/B/E/S.

Walgreen again said it faced continued pressure as government agencies cut back on prescription drug payments.

Walgreen's prescription sales at drugstores open at least a year rose 4.1 percent. The company filled 210 million prescriptions, up 5.8 percent over last year's third quarter.

Quarterly sales rose 6.8 percent to $18.37 billion and same-store sales rose 4.1 percent.

During the quarter, Walgreen sold its own pharmacy benefits management unit. It also bought drugstore.com inc as it tries to grow online.

(Additional reporting by Lewis Krauskopf in New York; additional writing by Brad Dorfman in Chicago; editing by John Wallace, Matthew Lewis and Andre Grenon)

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