CVS-Caremark: A Drug-Benefit Behemoth

The companies are merging to create a $75 billion giant. Investors turned thumbs down on both stocks Wednesday

CVS Corp. (CVS) and Caremark Rx (CMX) announced a merger agreement Nov. 1 as the two pharmacy benefit management heavyweights search for ways to improve their efficiency and U.S. market dominance.

The deal calls for Caremark shareholders to receive 1.67 CVS common shares for each Caremark share held (valued at just over $20 billion based on the $28.18 trading price of CVS stock late in the Nov. 1 session). The new company will be called CVS/Caremark and be headquartered in Woonsocket (R.I.). The combined pharmacy services business, will operate out of Nashville (Tenn.).

The companies project combined 2006 revenues for CVS and Caremark of approximately $75 billion, after adjustments. CVS/Caremark will have more than 180,000 employees, including more than 21,000 pharmacists and nurse practitioners.

CVS, best known for its retail drugstore business, has a pharmacy benefits management business under its PharmaCare organization. Meanwhile, Caremark offers benefit programs for prescription drugs and has retail pharmacies for its plan participants, among other things.

"This merger creates a significant platform to address the needs of both payors and consumers by providing high-quality, cost-effective services in a manner that is convenient, flexible and easy for the consumer to navigate and understand," said Caremark CEO Mac Crawford in a press release.

"This merger is a logical evolution for CVS, Caremark and the entire pharmacy industry," said Tom Ryan, CEO of CVS.

Investors turned an initial thumbs down on the news. After the merger announcement, CVS' stock price slid 8.2% to $28.18 per share on the New York Stock Exchange, while Caremark shed 3.1% to $47.73 per share.

Before the official announcement Nov. 1, the two companies issued a statement confirming they were discussing a deal after a New York Times report that they were in talks.

Ahead of the official announcement, Wall Street analysts expressed differing opinions on the potential deal.

"We believe such a transaction would fit well with CVS's long-term strategy to increase the size and offerings of its pharmacy benefits management business, eliminate a major competitor for its retail drug business and potentially result in scale and distribution efficiencies," Standard & Poor's Corp. analyst Joseph Agnese said in a research note. (S&P, like, is owned by The McGraw-Hill Companies.) Agnese reiterated his strong buy recommendation on CVS stock. As for Caremark, S&P analyst Phillip Seligman kept his buy rating on the shares.

"We are not surprised to see strategic buyer interest in [pharmacy-benefit managers] given attractive valuations," said Citigroup analyst Charles Boorady in a Nov. 1 research note issued ahead of the official aannouncement.

Boorady notes that both stocks are off

their highs this year, and that the market oversold shares of PBMs and managed care organizations becasue of concerns about Wal-Mart's (WMT) healthcare initiative, the potential for a cut in the average wholesale price of prescription drugs, and upcoming U.S. Congressional elections. If Democrats take control of even one house of Congress, it would raise the odds Congress might amend the Medicare Part D legislation to let the government negotiate drug prices (see, 10/27/06, "How the Election Could Move the Markets").

Before the merger announcement, Deutsche Bank analyst Bill Dreher cut his rating on CVS to hold from buy. In a Nov. 1 research note, Dreher said that should CVS acquire CMX, he

believes that increased uncertainty about future results could pressure CVS shares in the short term, while long term improvements would be at least a year away, though they could prove "highly beneficial". He lowered his price target on the stock to $30.

CVS and Caremark both report third quarter results on Nov. 2.

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