Summary
- Aetna has entered a deal to acquire Humana.
- CVS Health is currently contracted to operate Aetna’s pharmacy benefit management (PBM) business.
- Aetna is considering the possibility of creating a standalone PBM segment in-house.
- A new PBM business could potentially pull subscription volume from CVS.
The pharmacy benefit management business has been very good for CVS Health Corp. The second largest drugstore chain in the US made a smart move in 2007 by acquiring PBM company Caremark Rx, and now it is the second biggest after Express Scripts Holding Company.
It has been so successful for the drugstore chain that it makes up about 60% of CVS’s revenues. Still, it makes sense to diversify a company’s income streams so that they don’t come from too few sources or customers. CVS gets that, and that’s maybe why the company has made an acquisition of Omnicare Inc and will be buying the 1,660 or so pharmacies of Target Corporation located within Target stores.
Actually, these two events have come at a good time in light of the proposed takeover of Humana by Aetna. The large health insurer may be eyeing the attractive revenue potential of setting up its own pharmacy benefit management business internally. At the conference call where management of both companies were talking about the future operations, the idea of creating a stand-alone PBM was discussed.
Humana is the number six largest PBM with 6% of the market in 2014. That’s only a quarter of CVS’s 24% market share, so that wouldn’t really ring any major alarm bells. However, Aetna has a 12-year long-term contract agreement with CVS to operate as Aetna’s PBM, which started in 2010;according to Forbes, the agreement could possibly end as early as 2019.
I think this is significant since in the conference call Aetna said if it had its own PBM right now, it would cover over an estimated 600 million prescriptions in 2015. On a stand-alone basis, that PBM would be the fourth largest.
So the big question would be how much of CVS’s current PBM prescription volume would potentially be affected if Aetna didn’t renew their agreement in a number of years from now.
To put that 600 million prescriptions into perspective, at the top, PBM market leader Express Scripts processes over 1.3 billion prescriptions. CVS would be just under that, maybe 1.3 billion or slightly below. An Aetna-Humana PBM with 600 million prescriptions could possibly take up a sizable chunk of CVS’s current volume.
Then, there’s UnitedHealth Group. The company that owns the largest health insurer in the US is buying out Catamaran, the number four largest PBM with 9% market share. UnitedHealth operates number three OptumRx currently, so the combined businesses would process about 1 billion prescriptions. UnitedHealth also thinks the PBM business is a good earner, and is bulking up its market share.
As you can see, the consolidation of the PBM market and rearrangement of the market leader rankings will increase competition and may change matters for CVS in the mid to long term. CVS still has a firm position, but the Omnicare and Target pharmacies acquisitions are good insurance for steady future growth.
CVS is also smart to take advantage of Target’s need for restructuring after it shuttered all of its Target Canada stores. CVS gets an established network of drugstores all ready to expand the drugstore brand. When this deal closes, it will be the number one largest drugstore chain in the US. It’s behind Walgreens Boots Alliance in store count (around 7,800 vs 8,600), but the Target pharmacies will push it into the top place.
The Omnicare buyout will allow CVS to provide pharmacy services to long-term care facilities, and extend its reach into medicine for aged seniors and chronic care patients. The baby boomer generation is reaching retirement age, so there will be growing demand for healthcare services. To me, that sounds like a long-term opportunity for steady, reliable growth.
With these two acquisitions, CVS is growing its retail pharmacy business and branching out into public drug supply programs that may not be as profitable, but are steady earners.
CVS is planning well for the future, and I expect the drugstore chain will keep expanding from here. The next step is to integrate the Target pharmacies, improve upon costs and reap better revenues. The company has a good stock story, and I think it will continue to be a solid growth stock.
Date: July 13, 2015