By Bill McGilton
Ernest Gallego’s policing career ended the moment the tow truck slammed into his patrol car.
The accident inflicted permanent back injuries that left Gallego struggling with chronic pain.
As a Los Angeles police officer, Gallego was credited with saving lives. He had once even rescued two motorists in a severe flood.
But during the two decades that followed his accident, Gallego underwent multiple back surgeries. And he was treated with various pain medications.
Eventually, he was prescribed the painkiller OxyContin, a slow-release pill containing oxycodone. Oxycodone is also the active ingredient in medications like Percocet. More important, oxycodone is an opioid, a highly addictive narcotic drug one-and-a-half times more powerful than morphine.
Drugs like this have properties similar to opium and heroin. Oxycodone and hydrocodone (the active ingredient in Vicodin) are semi-synthetic opioids that bind to receptors in the brain and spinal cord – lessening the perception of pain.
Normal people, contending with chronic or acute pain, being treated by accredited medical professionals.
And when these drugs were developed back in the 1990s, they promised that relief. But they also unleashed a tragedy…
Within a year, the meticulously neat Officer Gallego had become the unkempt and groggy Ernest. He slept all the time. Often, he couldn’t even stand up straight. He had become an addict.
Gallego’s father begged the doctor to stop prescribing OxyContin. His mom tried to hide his pills. Gallego couldn’t get his addiction under control. Eventually, it cost him his life.
Coroners found lethal levels of oxycodone in his blood when he died in 2012.
The Los Angeles Times told Gallego’s story in a 2016 article on the nation’s growing problem with OxyContin. He was one of many.
And all of those stories are similar to his… normal people, contending with chronic or acute pain, being treated by accredited medical professionals.
They received legitimate prescriptions to ease pain from surgeries or injuries… prescriptions that became abused over time. Opioid addicts aren’t just “partiers” or “bums.” Many times, they’re normal people looking for relief.
According to a 2016 study, around 30% of Americans suffer from some form of acute or chronic pain. And that number jumps to 40% among older people.
Before we fully understood the addictive nature of these drugs, synthetic opioid painkillers were considered a breakthrough for these patients. They are now the most prescribed form of medicine in the U.S. – with around 215 million prescriptions dispensed per year, as of 2016 (the most recent data available).
The U.S. Drug Enforcement Administration (DEA) cautions that these drugs are highly dangerous and have a high potential for abuse and addiction. And yet, prescriptions remain common.
Given the number of prescriptions, the drugs’ addictive nature, and the fact that patients’ tolerance can increase with use, it’s not surprising that people have begun to call it an “epidemic.”
In 2016 alone, 42,249 people died from opioid overdoses… Many of them were just like Ernest Gallego.
Right now, the public, the government, and outside competition is stacking up against the wholesalers that distribute these drugs.
Let’s take a look at the industry that is fueling the widespread drug distribution that we’re seeing…
The Most Vulnerable Players in the Drug Market
It’s not an exaggeration to say that in the opioid epidemic, the “Big Three” drug wholesale distributors – McKesson, AmerisourceBergen, and Cardinal Health – bear a huge share of the blame. Collectively, the Big Three hold 85% of the opioid-distribution market. Their reckless distribution practices are flooding the market with opioids.
According to the more than 350 lawsuits filed by states, counties, and municipalities at the end of February 2018, the distributors have been woefully irresponsible.
Analysts estimate that opioids could contribute to nearly half a million deaths over the next decade.
You see, companies have to obtain licenses to distribute drugs… especially controlled substances. The government imposes strict duties on distributors – requiring them to identify, stop, and report suspicious orders.
These lawsuits say that the companies with these licenses have neglected their duties. And they’re also being accused of outright fraud. Allegations include regularly filling orders so large that there could be no legitimate purpose.
Many believe these neglectful practices have contributed to the tragedy that we face in the U.S. today. Drug overdoses are now the No. 1 cause of death for Americans under 50. And analysts estimate that opioids could contribute to nearly half a million deaths over the next decade.
The problem has become so massive that it’s causing strain on state and local governments who pay for treatments. And that doesn’t even count the associated law-enforcement costs.
All told, Bloomberg Intelligence estimates the costs at about $20 billion a year.
Governments can no longer look the other way.
One of the worst offenders is Cardinal Health, a $16 billion pharmaceutical distributor. As of the end of February, it was charged or named in at least 343 lawsuits – up from 100 in the previous quarter. (Yes, that’s an added 243 lawsuits in just one quarter.)
Cardinal Health has a history of filling orders of opioids for illegitimate business purposes – despite having sophisticated tracking systems in place to prevent it.
And these activities have continued for years… even after the DEA issued multiple suspension orders at several of its facilities around the country for failure to maintain control of hydrocodone.
In 2008, Cardinal admitted to selling opioids with no legitimate purpose – resulting in a $34 million fine.
In 2012, the company admitted to failing to maintain effective controls and failing to detect and report suspicious orders of controlled substances. As a result, Cardinal’s license to distribute drugs from its Lakeland, Florida facility was suspended for two years. It later settled for $44 million. In January, it settled a case with West Virginia for $20 million – that stemmed from similar failures back in 2012.
Despite all the litigation, suspensions, and fines, Cardinal has not changed its practices. At least not according to Kentucky’s attorney general, who filed a lawsuit against Cardinal in February. The complaint states that Cardinal was “neither halted nor deterred from these penalties.” And that Cardinal profited while ignoring all the red flags – allowing prescription opioids to be diverted for illegal use.
And it’s not just Kentucky. It’s all over the country. Lawsuits in other jurisdictions accuse Cardinal of similar activity.
The growing number of lawsuits means we may eventually see a “Big Opioid” settlement similar to the “Big Tobacco” settlement of 1998 – where the four largest U.S. tobacco companies agreed to pay $246 billion to cover the costs of smoking on public health.
At a minimum, all the litigation and public outcry means stricter regulation and hefty fines are on the way.
Stricter regulation combined with increased levels of competition means that business conditions for pharmaceutical distributors are about to get a whole lot worse.
That’s particularly bad for Cardinal Health. It’s already operating on razor-thin profit margins.
Now let’s take a look at the rest of the distribution industry and see why the competition is so threatening…
The Pharmaceutical Distribution Industry
Pharmaceutical distributors act as middlemen between drug manufacturers and health care providers. Their role is limited. They buy medicine from drug manufacturers and resell the medicine to health care providers. Most pharmacies, hospitals, long-term-care facilities, clinics, and other health care providers purchase medicine wholesale through a pharmaceutical distributor. Health care providers then resell it to patients at a markup.
Distributors don’t deal with insurance companies, patients, or coverage. They simply house and transport medications. So when a prescription is filled at a local pharmacy, the pharmacy would reorder drugs from the distributor.
Typically, pharmaceutical distributors maintain large supplies of medicine at various locations around the country. The medicine waits in these hubs until it’s needed to fulfill an order.
Having large amounts of medicine in storage also serves to regulate the overall supply. The manufacturer knows it needs to make more medicine based on the rate distributors run through it.
But pharmaceutical distributors must adhere to strict regulations around their products. They must keep the medicine under optimal and secure conditions. It’s a huge logistics operation.
Competition is fierce. And margins are slim. But it’s about to get worse… A new competitor is getting ready to enter the business.
Three hundred of the nation’s largest hospitals, and possibly the U.S. Department of Veterans Affairs, are setting up their own non-profit, FDA-approved generic-drug manufacturing company. This is happening now. The cost of generics at hospitals is out of control.
Once this jointly owned company is up and running, there will be less need to purchase generics wholesale through distributors like Cardinal Health.
These threats are real.
Incredibly, Cardinal isn’t worried. According to Chief Financial Officer Jorge Gomez, the purchasing process is managed in a way that’s hard for other vendors to duplicate based on Cardinal’s clinical, regulatory, and legal knowledge.
Gomez goes on and insists that competition from new distributors is “a lot of noise.” And he doesn’t see Cardinal Health’s customers interacting with them.
It’s a very shortsighted view.
And it’s not just Cardinal Health looking the other way, ignoring the massive threats. Wall Street is, too…
As always, Wall Street is myopically focused on estimates of increased sales and earnings. Investors assume that people need drugs and will use more drugs in the coming years. So that has to be good for a drug distributor, right?
Wall Street is making the fatal assumption that everything will continue as is forever. Disruption is something only to consider when it’s right in your face… when it’s too late.
But we know better…
Already, there’s been an explosion of opioid litigation cases on the county and municipal levels. New York City just filed a suit. Look for more states to join… putting pressure on the federal government to take action.
Wall Street is making the fatal assumption that everything will continue as is forever. Disruption is something only to consider when it’s right in your face… when it’s too late.
Many investors are still unaware of the extent of the litigation. The settlement expenses and fines can end up being enormous. In the Big Tobacco settlement, the four largest tobacco companies agreed to pay two-and-a-half years of the government’s health-related costs. If a similar settlement is worked out with opioids, we’re looking at a potential $50 billion settlement. And it could be higher. Either way, we’re talking huge money.
Cardinal’s margins are slim. Its business metrics are bound to get worse as regulators crack down on its practices. As the market becomes aware of these risks and Cardinal’s involvement, look for the risk to be reflected in a lower stock price.
Plus, any firm willing to take on Cardinal now must be ready to sign up for years of difficult litigation and bad press… making it an unattractive takeover candidate.
The bottom line: There’s significant risk of disruption to Cardinal’s business through competition and litigation. And we don’t think the market appreciates the extent of the risk.
Bill McGilton is the editor for Stansberry’s Big Trade – a speculative options trading service aimed at profiting from the worst corporate credit and companies with broken business models in America.
Bill has been a lawyer for the past 16 years, with experience in corporate litigation research, including securities, contracts, anti-trust, options backdating, foreign-exchange fixing, and trademark and patent infringement.
