The largest firms in the U.S. and European drug channels are teaming up to leverage the increasingly important benefits of scale, according to Fitch Ratings.

The forms of these business combinations are diverse, both in their structure and progress. But each relationship makes sense for those involved as scale increasingly matters in healthcare, particularly in the buying and selling of pharmaceuticals.

CVS Caremark Corp. (CVS) and Cardinal Health, Inc. (CAH) were the latest to join forces, announcing in December 2013 that they would combine their generic drug purchasing power in a 10-year joint venture agreement. Walgreen Co. and Alliance Boots GmbH (collectively, WAG), which initially teamed up in June 2012, formed a unique long-term relationship with AmerisourceBergen Corp. (ABC) in March 2013. In October 2013, McKesson Corporation announced its $8.3 billion (upsized to $8.5 billion) intent to acquire German drug distributor and drugstore operator Celesio AG. However, that bid failed last week as a function of German law.

It seems as though most of the largest firms have chosen their partners. But Fitch expects this trend will continue and allow for greater generic profits and efficiencies for the drug channel in the intermediate and longer term. Large drug purchasers not yet involved in explicit purchase power combination plays include U.S. pharmacy benefit manager and mail-order pharmacy company Express Scripts, Inc., U.S. drugstore chain Rite Aid Corp., and European drug distributor Phoenix Pharmahandel Aktiengesellschaft & Co KG.

Historically, most of the largest drug channel participants have sourced and distributed the majority of their own generic drug volumes. The ABC-WAG agreement is the starkest change from this model, as ABC will distribute virtually all drug volumes to WAG, likely by year-end 2014. The CAH/CVS agreement could signal a shift in a similar direction but nothing has indicated that to be the case yet.

There are notable differences in the arrangements, although amassing scale is common to all of them. ABC-WAG's agreement includes partial equity ownership of ABC by WAG, plus the aforementioned 10-year comprehensive distribution agreement; the CAH/CVS deal is only currently a purchasing joint venture for generics; and the MCK/Celesio deal was intended to be an outright acquisition. It is at this time too early to predict the longer-term credit implications and ultimate success of each relationship structure.

Notably, the largest generic drug makers have also been amassing scale in recent years. Today, the four largest generic drug firms -- Teva Pharmaceutical Industries Ltd., Sandoz (a division of Novartis AG), Actavis, Inc., and Mylan Inc. -- together represent a significant portion of generic drug volumes in the U.S. and Europe. Fitch expects that consolidating purchasers could pose a threat to these firms' profitability in the intermediate term.

Fitch thinks it will likely be mid tier and smaller generic firms that are affected the most. Smaller generic firms may not be able to supply the quantity of product demanded by the new global drug purchasers and, thus, may miss out on key contracting opportunities going forward. Especially as the largest generic firms expand into emerging markets, where access to healthcare and acceptance of generic drugs is generally improving, smaller generic firms are likely to encounter growing competitive pressures.

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