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CVS's buy will expand its role

By TIMES WIRES
Published November 2, 2006

CVS Corp., the second-biggest U.S. drugstore chain, agreed to buy Caremark Rx Inc. for $21.2-billion in stock to create a combined service that manages drug-benefit plans and sales at pharmacies.

Investors will receive 1.67 shares of CVS stock for each share of Caremark, the companies said Wednesday.

The transaction values Caremark at $48.53 a share, 1 percent less than its closing price Tuesday. CVS chief executive Tom Ryan will remain CEO. Caremark chief Mac Crawford will become chairman.

CVS will change its name to CVS/Caremark Corp. The company will be more competitive with Wal-Mart Stores Inc.'s 3,850 pharmacies, which have announced discounting on generic drugs in 27 states. CVS also will be a larger rival to Medco Health Solutions Inc.

"It makes CVS both a competitor and a supplier to the other chain drugstores," said Matthew Kaufler, who helps manage $2.5-billion, including CVS shares, at Clover Capital Management in Rochester, N.Y. "This could truly be a transformative event."

The companies called the transaction a "merger of equals." CVS shareholders will own 54.5 percent of the company.

The combination will lower costs by $400-million and may add to earnings in the year after it's completed.

CVS said it expects to close the transaction in six to 12 months.

CVS's acquisition of Caremark means a major expansion of the drug chain's pharmacy benefit management business, PharmaCare. PharmaCare is now the nation's fourth-largest PBM.

Though CVS got into the mail-order drug business in 1983, that business grew significantly in mid 2004 when it acquired Eckerd Health Services (along with 1,200 Eckerd stores in Florida and Texas).

For the past two years, CVS has leased space in Eckerd's former headquarters in Largo for about 400 employees of a PharmaCare mail-order operation. The effect of the Caremark deal on the Largo employees was not known Wednesday.

Despite its mail-order pharmacy presence in Pinellas County, CVS is best known in the Tampa Bay area for its hundreds of retail locations. The retailer has about 661 of its nearly 6,200 stores in Florida.

Caremark, the nation's largest pharmacy benefits manager, has only one Florida location, a mail-order pharmacy in Miramar.

Robert Garis, associate professor of pharmacy at Creighton University in Omaha, Neb., said he believes CVS proposed the merger to gain an edge in its battle with archrival Walgreens.

Caremark, meanwhile, may be feeling pressure from several ongoing federal and state investigations. Florida is one of four states, along with the U.S. Justice Department, that joined a false claims case against the company, which is pending in federal court in Texas.

Garis said Caremark may also fear that Wal-Mart's recent price-cutting of generic drugs will force pharmacy benefit managers to shave what have been lucrative margins on generics to retain customers.

"I can see some efficiencies in a vertically integrated business model," Garis said of a Caremark-CVS merger. "It remains to be seen if it will mean better prices for consumers."

Investors react

Caremark is joining a company whose profit is growing more slowly. CVS said Wednesday that third-quarter net income climbed 12 percent, to $284.2-million, or 33 cents a share, on sales of generic drugs. Revenue rose 25 percent, to $11.2-billion.

Caremark reported net income of $288.6-million, or 67 cents a share, up 25 percent from a year earlier. Revenue rose 13 percent, to $9.1-billion.

Shares of Caremark, based in Nashville, fell $1.06, or 3 percent, to $48.17 in New York Stock Exchange composite trading. In after-hours trading, it fell slightly, to $48, at 8 p.m.

CVS dropped $2.32, or 7.4 percent, to $29.03. In after-hours trading, it gained back 22 cents, to $29.25, at 8 p.m.

CVS, based in Woonsocket, R.I., is buying Caremark at 18 percent less than its historic high of $59.64 set last month. The stock has almost tripled since the start of 2002, compared with a 19 percent gain on the Standard & Poor's 500 index.

"I am disappointed," said John Farrall, an analyst at National City Private Client Group, which owns 1-million shares of Caremark. "I have to hear more about why we should approve it."

Controlling costs

Caremark is hired by employers to keep costs down by seeking out drug manufacturers and pharmacies with the best prices. Health insurance plans and employers who buy drugs are turning to the companies to help counter rising health care costs. Spending on prescription drugs in the United States increased 5.4 percent, to $251.8-billion, in 2005.

As a result, Caremark and its competitors have been taking advantage of a flood of generic copies of brand-name drugs, such as Merck & Co.'s Zocor.

Pharmacy-benefit managers, who lower costs for health plans and employers by buying in bulk, and by minimizing waste in the handling of expensive biotechnology drugs, can switch most of their mail-order customers from high-priced brands to low-cost generics in a matter of days or weeks.

By selling these generic drugs, pharmacy-benefit managers generate higher profit margins.

Medco said this year's patent expirations, including Zocor, would help lift 2006 earnings by as much as 11 cents a share.

"We want everyone to play in this," Ryan said on a conference call with analysts and investors. "We want to lead the change instead of reacting to it."

Drug-benefit managers have been merging in recent years.

Last year, Medco acquired Accredo Health Inc. for about $2.62-billion in cash and stock, expanding its management of faster-growing specialty drugs. Caremark took over Advance PCS for $6.1-billion in 2004.

Medco bought specialty pharmacy provider Accredo Health Inc. last year, while Express Scripts, the third biggest, acquired CuraScript Pharmacy Inc. in 2004 and Priority Healthcare Inc. last year.

Garis believes the CVS-Caremark deal won't be the last in the continuing evolution of the drug supply system.

"It wouldn't surprise me to see Walgreens and Medco all of a sudden in bed together," Garis said.

[Last modified November 1, 2006, 23:13:34]