CVS to buy Caremark for $20.7 billion
Drugstore chain CVS Corp. (CVS.N: Quote, Profile, Research) on Wednesday agreed to acquire pharmacy benefits manager Caremark Rx Inc. (CMX.N: Quote, Profile, Research) for nearly $21 billion to expand its prescription benefits and mail-order business.
CVS will exchange 1.67 of its shares for each share of Caremark, whose stock-option practices are under federal scrutiny. CVS’ stock fell 7.5 percent on the news, putting the value of the deal at around $20.7 billion, or $48.48 a share.
The offer represents no premium to shareholders of Caremark, which traded above $49 on the New York Stock Exchange on Tuesday and as high as $59.25 in September.
The deal comes at a time when the traditional pharmacy model is under pressure from intense competition, including from mail-order operations, and new issues, such as the influx of prescriptions under Medicare Part D. Mail-order drugs have eroded the business of retail pharmacies, siphoning off customers who buy medicines and also shop for other items.
CVS has been signaling they were looking to make a deal involving a PBM for the past 12 months, said Frank Sustersic, a senior portfolio manager with Turner Investment Partners.
"I’m not surprised that CVS is an acquirer. I’m a little bit surprised at the transaction price," Sustersic said, referring to the lack of a premium.
CVS closed at $29.03, down $2.35, or 7.5 percent. Caremark shares closed down 2.15 percent at $48.17. The news also dragged down the shares of rivals in both industries, including pharmacy benefits company Medco Health Solutions Inc. (MHS.N: Quote, Profile, Research), which shed 5.3 percent to $50.67, and drugstores such as market leader Walgreen Co. (WAG.N: Quote, Profile, Research), which fell 3.6 percent to $42.11.
"When was the last time you saw a deal that hurt everyone involved? It’s dragging down both companies and stocks in both sectors. How could shareholders on either side of this deal OK it?" said one trader who declined to be named.
The deal lacks a takeover premium at a time when the merger market is near a record level of activity and average deal premiums hover around 20 percent, according to research firm Dealogic
Now, the market ponders whether others drugstore chains will try to follow in CVS’ acquisitive footsteps.
"I think it definitely increases the possibility that we’ll see an acquisition of another PBM player, possibly by a drugstore, or at least a collaboration between the two," said S&P Equity analyst Joseph Agnese.
COMPETITIVE PRESSURES AT RETAIL
Retail pharmacies have built their own mail-order operations to try to keep pace with pharmacy benefit managers. Further adding to pressure on retailers, Wal-Mart Stores Inc. (WMT.N: Quote, Profile, Research) has begun selling some generic drugs for just $4 for a one-month supply.
"The growth of the mail channel has been a concern to the retail pharmacies for several years," Cowen & Co. analyst Kemp Dolliver said. "That’s the biggest thing: Mail not only takes business away from the back end of the retail pharmacy, but essentially reduces the traffic."
Caremark and other pharmacy benefit managers administer prescription drug benefits for employers and major health plans, brokering deals in part by buying medicines in bulk from manufacturers. They also have large pharmacies that deliver prescriptions through the mail.
"The proposed merger of CVS and Caremark Rx signals a further shift in who controls the prescription drug market in the United States," said Sean Brandle, head of the Rx consulting group at Segal Co.
The deal sparks longer-term questions about integration, possible customer and vendor conflicts and the potential that problems at Caremark may be driving the merger, said William Blair analyst John Kreger.
In May, Caremark said the federal prosecutor for the Southern District of New York subpoenaed its records on stock- option grants. The Nashville, Tennessee-based company also received a letter of informal inquiry from the U.S. Securities and Exchange Commission.
John Farrall of National City Private Client Group said buying Caremark would help boost CVS’ offerings under the new Medicare Part D prescription drug benefit.
Caremark, spun off from Baxter International Inc. (BAX.N: Quote, Profile, Research) in 1992, bought rival AdvancePCS for $6.7 billion in 2004. Farrall said it ranked second behind rival PBM Medco Health Solutio1ns Inc. (MHS.N: Quote, Profile, Research) in terms of number of prescriptions managed.
CVS has grown rapidly through acquisitions. In 2004, it acquired about 1,260 Eckerd drug stores and Eckerd’s mail-order and pharmacy business from J.C. Penney Co. Inc. (JCP.N: Quote, Profile, Research). Earlier this year it bought about 700 Sav-On and Osco drugstores from Albertsons Inc. and bought MinuteClinic, the biggest U.S. operator of retail-based health clinics.
Separately, CVS posted a 12.5 percent rise in third-quarter profit. Caremark posted a 24.7 percent increase in third quarter earnings.
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