Latest / The Buyout Show with Fexingo: Private Equity, Roll-Ups, and Business Acquisitions / How Private Equity Is Rolling Up Independent Pharmacies
Transcript
- Lucas: Luna, I want to talk about a quiet consolidation wave that's been reshaping Main Street healthcare for the last five years or so, and it's happening inside your local pharmacy. Luna: You mean the independent pharmacy, not the CVS or Walgreens, right? Lucas: Exactly. There are about 20,000 independent pharmacies left in the US, down from over 24,000 a decade ago. And since 2020, private equity has acquired more than 2,000 of them. That's roughly ten percent of the entire independent channel, gone in five years. Luna: Whoa. I knew PBMs were squeezing them, but I didn't realize PE was that active. Lucas: And the pace is accelerating. The poster child here is a platform called Elevate Pharmacy. They started in 2021 with about ten stores in the Midwest, and within 18 months they'd bought 150 locations across eight states. They're backed by a PE firm called Shore Capital Partners. Luna: So what does Elevate actually do differently from an independent owner once they buy the store? Lucas: That's the key question. The pitch is that by aggregating volume, they can negotiate better reimbursement rates from pharmacy benefit managers — the PBMs — and achieve operational efficiencies in purchasing, billing, and compliance. They keep the local pharmacist on staff, often with an earnout, so the store retains its community face. Luna: But do they actually get better PBM rates? Because the PBMs are notoriously opaque. Lucas: They do get some leverage. A 150-store chain has more clout than a single owner, but the PBMs — the big three are Caremark, Express Scripts, and OptumRx — still hold most of the cards. What PE really does is standardize the back office: centralized purchasing, uniform software, consolidated billing. They can shave two to three percent off operating costs, which in a business with net margins around two to three percent, is huge. Luna: So the margin goes from razor-thin to maybe slightly less razor-thin. But the store still makes most of its money on dispensing fees and a tiny markup on generics, right? Lucas: Right. The average independent pharmacy fills about 200 prescriptions a day. The dispensing fee from a PBM might be a dollar fifty, and the ingredient cost reimbursement on a generic is often below the pharmacy's acquisition cost. That's the famous 'negative spread' issue. Pharmacies actually lose money on some generics and rely on the professional services — immunizations, medication therapy management — to stay afloat. Luna: So if the economics are that tight, how does PE expect to generate a return? They're buying at maybe four to six times EBITDA, but the EBITDA itself is tiny. Lucas: The thesis is that by rolling up hundreds of stores, you create a platform that can diversify revenue. Elevate, for example, has been adding specialty pharmacy services — think expensive biologics for cancer, rheumatoid arthritis, hepatitis C. Those have much higher margins and are less subject to PBM clawbacks. Specialty drugs now account for over fifty percent of pharmacy revenue nationally, even though they're only a small fraction of prescriptions. Luna: So PE is essentially using the community pharmacy as a distribution point for high-margin specialty drugs, while the front-end retail — the candy, the cards, the over-the-counter stuff — is almost irrelevant. Lucas: Exactly. The front-end gross margins are actually higher, around thirty to forty percent, but the ticket size is tiny. The real arrow is specialty. And that's where the consolidation makes sense: an independent can't afford the credentialing, the cold chain logistics, the compliance infrastructure to handle specialty. A 150-store platform can. Luna: But here's what I worry about. When you standardize operations, you also standardize clinical decisions. If every store is using the same formulary, the same adherence software, are patients losing the personalized counsel that makes independent pharmacies valuable? Lucas: That's the tension. The pitch to the selling pharmacist is 'you stay, you keep your relationships, you just get a better PBM contract and a check.' But once the earnout period — typically three to five years — is over, the PE firm can replace the pharmacist with a lower-salaried staffer. And at that point, the community touch starts to erode. Luna: There's also a regulatory risk. The FTC has been looking at PBM consolidation, but they've also started asking questions about vertical integration and roll-ups in healthcare. Do you see that affecting these pharmacy platforms? Lucas: It could. In 2024, the FTC sued the three largest PBMs over rebate practices. If that litigation leads to more transparency in reimbursement, the independent pharmacy's margins could improve — which would actually reduce the urgency to sell. But for now, independents are caught between shrinking reimbursements and rising operating costs, and PE is offering a lifeline. Whether it's a good lifeline or a trap depends on the structure of the deal. Luna: Speaking of which, I know these conversations can be valuable for people thinking about their own business or career. If this show has added something to your thinking, we do keep it ad-free, and listener support is what makes that possible. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small gesture that goes a long way in keeping things independent. And back to the pharmacy roll-up — I want to zoom in on one actual deal term that's common in these acquisitions, because it's a little counterintuitive. Luna: Okay, I'm listening. Lucas: Many PE buyers use what's called a 'sweat equity' earnout. The selling pharmacist gets paid a base price for the assets — maybe three times EBITDA — but the bulk of the upside comes from a multi-year earnout tied to revenue growth and patient adherence metrics. If the pharmacist hits certain targets, they can earn another two to three times EBITDA. That aligns incentives, but it also means the pharmacist is essentially working for a bonus that may never materialize if the market turns. Luna: So the PE firm caps its downside. If the store performs, the pharmacist gets a share. If it doesn't, the firm just bought a pharmacy cheap. Lucas: Exactly. And in practice, a lot of pharmacists are finding that the promised synergies — like better PBM rates — take longer than expected because the PBMs push back. So the earnout targets get harder to reach. I've seen cases where the pharmacist ends up earning less in total than if they'd just kept running their own store. Luna: But the selling price itself is often life-changing for a retiring owner. So it's not all bad. It's just... complicated. Lucas: Right. And the trend isn't slowing. There are now over a dozen pe backed pharmacy platforms operating nationally. The largest, a company called Apotheco Pharmacy Group, has over 400 locations. The question is whether these rolled-up chains can generate the returns the firms projected, especially if interest rates stay where they are and exit multiples compress. Luna: And if they can't, we might see a wave of distressed asset sales, which would be a second consolidation wave. But that's probably a topic for another episode. Lucas: For sure. For now, the independent pharmacy is becoming less independent every year. And the biggest drivers aren't just PE — it's the PBM structure that makes the business so hard to run alone. Luna: So the question for a pharmacy owner listening today would be: do you sell now, or do you try to hold out for regulatory relief that might never come? Lucas: That's the million-dollar question. And the answer probably depends on their age, their debt, and their appetite for uncertainty. But what's clear is that the roll-up machine is running, and it's not stopping anytime soon. Luna: Alright, I think that's a good place to leave it. Thanks, Lucas. Lucas: Thanks, Luna. Talk next time.