Overall we are willing to remain patient with CVS’s stock to see their new strategy being implemented. This could help change the complex healthcare landscape in the US.
We also see limited downside risk at this point, with the stock trading at 11.2x next year’s P/E, and offering a 2.8% dividend yield.
Why was the stock down on the announcement?
• Initial dilution of shareholder value
• Perception of increased difficulty to merge, even vertically
• Potential conflict of interest between CVS’s PBM business and Health Plans, which we believe they can answer by:
o creating enough value (thanks to scale) for health plans to remain with them
o having firewalls between PBM and Aetna’s business (I’m not a believer they can actually implement this, but management guided to it)
o historically, its competitor UNH was able to grow its PBM business outside of its own health plan
What are the risks?
• High leverage of 4.6x net debt/EBITDA (my calculations to deleverage to 2.9x in 2020) a risk for next 2 years if:
o Front-end store (convenience store) continue decline as it is challenged by online shift and increased competition
o Potential loss of business for its PBM segment
• Will have to convince consumers that CVS is no longer a convenience store but a “Health Hub”
• I do NOT believe Amazon is a near term threat to CVS’s pharmacy business but it’s been highly talked about in the news.
o Amazon guided to going into medical devices shipping, not drugs.
Why do we think the deal is attractive?
• Near-term cost synergies:
o $750M cost reduction opportunity
combining corporate functions
lowering pricing with vendors
combining some operations
• We like the long-term strategy, which we think will start being implemented in 2019:
o Vertical integration would bring a unique set of offerings to Aetna’s members which could help grow Aetna’s customer base
~80% of the US population lives within a couple miles of a CVS store, and roughly 50% of the US population lives within 10 miles of a MinuteClinic (currently CVS “only” has 1,100 clinics out of 9,600 stores)
o Reduction in cost of care:
Push for the use of MinuteClinics rather than ER
More integrated data analytics from visit to doctor to drugs impact on patient’s health
o Cutting out the middlemen in the current complex supply chain