Bireme Capital sees a value in Express Scripts Holding Company (Nasdaq: ESRX), a $34-billion market cap pharmacy benefit management (PBM) company in North America. In its Q3 investor letter. Let’s take a look at the fund’s investment thesis on ESRX:

Express Scripts (ESRX) is a company that manages the drug prescription approval and payment process for health plans, companies, and some government entities. In this role they are called the Pharmacy Benefits Manager (PBM). They pool the negotiating power of their customers and seek pricing concessions directly from the drug manufacturers or wholesalers, allowing clients to achieve better pricing than if they negotiated on their own. They also use their expertise to exclude some drugs from coverage—usually drugs for which there are cheaper or better alternatives. Finally, they are somewhat vertically integrated, operating a large mail order pharmacy called Accredo.

We believe the opportunity exists to buy ESRX at a discount to intrinsic value due to a dispute with one of their largest customers, Anthem. This conflict came fully to light in early 2016, when Anthem initiated a lawsuit that claimed $3B in annual overcharging by ESRX. ESRX’s stock price quickly fell from $85 to $65 and has yet to recover, despite the company posting consistently higher EBITDA and earnings since. In fact, with trailing free cash flow (FCF) per share above $6 at the time, this means that the multiple on the stock has collapsed from a healthy ~14x to just over 10x. Since then FCF has expanded and the stock price has declined further, creating a FCF multiple of about 8.5x at the end of the quarter.

Recently ESRX disclosed exactly how much EBITDA they make from their contract with Anthem, which expires 12/31/2019. At about 31% of total EBITDA, their profits on the Anthem business are material. However, we feel that a loss of the Anthem business is more than priced into the stock, and calculate they will earn about $4.50 per share in 2021 when Anthem has fully exited the relationship. At that point the core ESRX business, which grew EBITDA 6% last year, would trade at a still-discounted 13x multiple. We think ESRX is priced for above-market returns.