Your Primer to Healthcare Mergers and Acquisitions

Fall of Diplomat Pharmacy: 10 Things That Went Wrong

Feb 4, 2020

by Alan J. Hymowitz

Volume 7 Issue 3, February 4, 2020

In July 2015, Diplomat Pharmacy was the talk of the town. The company's stock had surpassed $51 per share — an all-time high and nearly quadruple its October 2014 initial public offering price. The company and its share price were buoyed by some noteworthy investments. In April 2015, Diplomat had completed its acquisition of BioRx, a major competitor. And in June 2015, it had acquired Burman's Specialty Pharmacy in a smaller, but still significant transaction. 

Momentum seemed like it was on the company's side, with Diplomat looking poised to be a major player for many years to come. One writer penned a piece for Seeking Alpha titled, "Diplomat Specialty Pharmacy: A True All-American Success Story!" in May 2016. The latter half of 2016 and 2017 saw Diplomat make numerous investments as the company pursued a growth-through-acquisitions strategy that also led to the expansion and launching of new service lines.

But, as it is often said, "the higher they rise, the harder they fall." In December 2019, UnitedHealth Group's OptumRx agreed to acquire Diplomat for about $4 a share in cash. That was a 31% discount (!) on Diplomat's previous closing price and, as Reuters described, "… a far cry from the company's peak market valuation in 2015 …"

What caused this "All-American success story" to come up so short on expectations? As is the case with a company of Diplomat's size (it describes itself as "the nation's largest independent provider of specialty pharmacy and specialty infusion services"), failure is rarely attributable to a single reason or even just a few. Rather, it's a confluence of factors. Some played more significant roles than others, but each contributed, and each offers crucial lessons for other independent pharmacies and healthcare businesses to learn from.

Diplomat Pharmacy Downfall

Here are 10 things that went wrong with Diplomat pharmacy.

Inability to adapt

Diplomat showed a tendency to struggle or take too long to adapt to changes and trends within the specialty pharmacy industry. These include developments concerning reimbursement, valuations, and cost of goods.

One prime example is seen in how Diplomat approached hepatitis C virus (HCV) medications. When there were reports of new HCV drugs in the pipeline that would be considerably cheaper, some companies responded proactively to the news and shifted their business model. Others, like Diplomat, believed that they would have at least a few years before the landscape changed. This decision proved shortsighted.

Increased competition

Diplomat's rapid ascension brought with it a target square on the company's back. Major players (e.g., Walgreens, CVS, Optum) set their sights on Diplomat in an effort to take away business and reduce market share. As the cracks that will be highlighted in this piece started appearing in Diplomat's armor, competitors pounced and exploited weaknesses for their own gain. 

Margin Compression

Not unique to Diplomat, but increasing pricing pressure from third-party payors resulted in margin compression. Whereas some companies become more conservative when faced with tightening reimbursement, Diplomat took the opposite approach. The company spent and spent and spent, acquiring competitors left and right — and often seeming to spend too much to do so. In commenting on Diplomat's acquisition of National Pharmaceutical Services in November 2017, Baird analyst Eric Coldwell told Reuters, "… it feels like Diplomat overpaid for another asset …" 

Opting out of pharmacy provider networks

It's a bit hard to knock Diplomat for this factor. The company made the wise decision not to continue participating in certain pharmacy provider networks because of poor pricing. Such an approach can often bring networks back to the table for negotiations and eventually improved pricing. But in this case, the tactic backfired, and the effects snowballed. Networks called Diplomat's perceived bluff and didn't cave, leading to substantial business losses. 

Failure to win new business

While Diplomat was the darling of the industry for a period, not everyone looked favorably upon the company. That included some provider networks, which found Diplomat's aggressive acquisition strategy unappealing. This led, in part, to these networks choosing Diplomat competitors as partners.

Diplomat also failed to capture some new business it desired when it was unable to match the offerings of competitors. The combination of losing existing business and an inability to capture new business is typically lethal for any company.

Integration shortcomings

Acquiring a company can be relatively straightforward. Integrating an acquisition, on the other hand, is usually quite difficult. Integrating many acquisitions in a short amount of time and hoping for a positive outcome is close to impossible, as Diplomat discovered.

As noted, the company went on a buying spree in the years that followed its IPO. With major business changes coming every few months — and sometimes even every month — the company struggled with effectively integrating each new acquisition while maintaining its core business, identity, and chain of command. The result was a foundation that started falling apart. This contributed to…

Exit of talent

The acquisitions created significant stress and uncertainty for some of Diplomat's top talent. As new companies came aboard, leaders often found themselves unsure of their job roles and responsibilities or discovered that an acquisition introduced management redundancy. The absence of clear company direction drove a lot of talent to the exits, often leaving those worker bees who stayed with Diplomat lacking strong leadership.

Unable to differentiate

In an industry where there is significant overlap in products and services delivered, companies must effectively differentiate themselves wherever and whenever they can to stand out from competitors. For a time, Diplomat seemed to do an impressive job of distinguishing its brand. But as the acquisitions and service lines increased, what made Diplomat "special" became muddied, and the company struggled to stand out against larger competitors. 

Alienating PBMs

In April 2018, Diplomat introduced its CastiaRx specialty benefit manager. This was a culmination of Diplomat's efforts to enter the pharmacy benefit manager (PBM) market. CastiaRx combined Diplomat's two recently acquired PBMs — LDI Integrated Pharmacy Services and National Pharmaceutical Services — with Diplomat's specialty pharmacy and infusion capabilities.

Unfortunately, as a report from The Motley Foonoted, Diplomat's move into the PBM space did not go smoothly. While CastiaRx generated millions in revenue from new business, this was "… overwhelmed by the loss of $200 million in previously disclosed Medicare Part D contracts, and the loss of an additional $120 million from new client losses and the pricing impact of contract renewals."

The decision by Diplomat to become a PBM was not welcomed by many existing PBM partners, some of which dropped Diplomat. Other challenges facing Diplomat at this time included the introduction of cheaper generics, volume declines, and competition from specialty pharmacies run by larger PBMs, which were eager to prevent Diplomat from achieving market penetration. 

In February 2019, Diplomat announced it was postponing the release of its fourth-quarter and full-year 2018 earnings, sending the stock down more than 50% to under $6 per share and an all-time low at the time. By August, reports came out that the company was considering a sale or acquisition.

Loss of major payer

Nearing the end of 2019, Diplomat was starting to look like a shell of the company it once was. In mid-November, Diplomat announced that by the end of the month, "… we will no longer participate in a significant group of specialty and retail networks with one of our largest payers. We were unable to reach an agreement to renew network participation rates. While this group of networks is not the only network group that we participate in for this payer, it does comprise the vast majority of the specialty pharmacy business that we do with this payer."

The news, together with a greater-than-expected loss, sent shares down to just over $3 per share and another record closing low. The stock would rebound a bit in the coming months, fueled, in part, by the prospects of Diplomat selling some or all of its assets, but would come crashing down again following the news of Optum's pending acquisition.

Diplomat Pharmacy Collapse: Closing Thoughts

Drug Channels report summarizes the rise and fall of Diplomat Pharmacy well. It begins by praising the company's leadership for taking a family-owned community pharmacy and turning it into the largest independent specialty pharmacy and a public company, but notes, "Alas, the specialty pharmacy market is reaching maturity, as PBMs and insurers dominate specialty drug dispensing channels. Diplomat has been unable to navigate the industry's evolution."

There are many lessons one can learn from Diplomat's rise and fall. I would welcome the opportunity to discuss them further with you and how they apply to the short- and long-term plans for your pharmacy.

Alan J. Hymowitz

Alan J. Hymowitz CM&AA

Managing Director

During the past decade, Alan has facilitated numerous, diverse M+A transactions in the pharmacy marketplace across the country, as well as providing strategic consultation to national pharmacies and similar organizations.  Prior to becoming an M+A advisor, he was a “hands-on” owner and manager in the pharmacy and home infusion healthcare marketplace for over 15 years and successfully sold his pharmacy to a national company after growing and diversifying their income streams in a very competitive market.  Alan's specialties in the pharmacy and home infusion marketplace include long term care, retail pharmacy, specialty pharmacy, and home healthcare, and he has attained the URAC Accreditation and Specialty Pharmacy Consultant designations, in addition to other recognitions.  His educational background includes a Bachelor of Arts from Rutgers University and a Master of Arts from the John Jay College of Criminal Justice.

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