The $21 billion question that investors have been asking since drugstore giant CVS Corp. (CVS) announced a merger with pharmacy benefits manager Caremark Rx Inc. (RMX): Why did Caremark sell when its stock is so cheap? On Nov. 1, CVS offered 1.67 shares for each Caremark share. After CVS stock sank 7% on the news, that worked out to about a $48 per share, or a $21 billion deal. That's no premium for shareholders of Caremark, which was trading at 49 at the time, more than 20% below where it was two months ago.
Many analysts haven't bought the argument of Caremark Chief Executive Edwin M. "Mac" Crawford that the combined entity, leading both the drugstore and mail-order prescription markets, will revolutionize the way customers get their meds. Some say the deal was rushed after Wal-Mart Stores Inc. (WMT) announced a drug discount plan in Florida on Sept. 23, threatening Caremark's heady 200% increase in profits since 2003. But Wal-Mart's relatively small effort wouldn't hurt Caremark's bottom line for years. "Why does Caremark think they need to change the model?" asks A.G. Edwards & Sons Inc. (AGE) analyst Andrew L. Speller, who is now questioning his own growth assumptions about the company. Even more puzzling, Caremark bought back almost 2 million of its own shares at an average $55 price in the third quarter. So why sell now?
It appears that Crawford's bet is as much political as it is strategic. At the time the CVS deal was negotiated, the Democrats were rapidly surging in the polls. And a Democratic Congress figures to be inhospitable for Caremark and the other pharmacy benefits managers (PBMs). With politics clouding future earnings growth, Crawford is selling "at the top of the cycle," says David D. Halbert, former CEO of AdvancePCS Inc., one of the nation's largest PBMs when it was acquired by Caremark in 2004. Crawford and CVS declined comment.
Near the top of Democrats' agenda is an overhaul of the Medicare "Part D" prescription drug benefit. It's well known that Big Pharma would suffer from this initiative. But what has been less widely appreciated is the impact it would have on middlemen such as Caremark. The aim of an attack on Part D would be to lower the price of drugs paid for by the government while reducing the need for the hundreds of complicated private plans offered by Nashville-based Caremark and its competitors.
CHANGE OF PLANS?
Indeed, part D was a big reason Caremark surged to the No. 3 spot on the BusinessWeek 50 list of top corporate performers. The company's SilverScript Insurance unit signed up more than 400,000 seniors by May 1. Combined with the behind-the-scenes services Caremark performs for plans of other insurance companies, it's among the 10 biggest Part D plan providers.
Republicans explicitly barred the government from negotiating with drugmakers in the original 2003 law. Instead, each of the hundreds of plan sponsors, including Caremark's SilverScript, cuts its own deals with the drug companies. PBMs then receive a percentage of those prices for administering the program to consumers, plus rebates from manufacturers. Caremark's revenue from retail drug claims rose almost 18%, to $6 billion, in the third quarter alone, due in large part to its Medicare Part D customers.
The Democrats' plan, according to Vicki Gottlich, an attorney at the nonprofit Center for Medicare Advocacy Inc., is to allow seniors to sign up for a single government-sponsored drug plan that would compete with all of the hundreds of private plans. If the government plan could offer lower prices and less complexity, it might win customers and prompt other federal and state programs to follow suit in their own pharmaceutical assistance programs, says Halbert. Government spending accounts for about 40% of drug sales. A move by Medicare to negotiate prices directly "has the potential of changing the industry," Halbert says.
It may be that Woonsocket (R.I.)-based CVS, which hit No. 39 on the BusinessWeek 50, is getting a bargain. The deal would create a sizable competitor, and scale will help since Wal-Mart has started to throw its weight around the pharmacy sector. Still, CVS and Caremark will have to tangle with a foe that has even more muscle than Wal-Mart--a Democratic Congress.
By Aaron Pressman, with Robert Berner in Chicago