CVS, Caremark Unite to Create Drug-Sale Giant

CVS, Caremark Unite to Create Drug-Sale Giant

In a tacit acknowledgment of the changing ways in which Americans get their prescription medications, drugstore chain CVS Corp. agreed to purchase pharmacy-benefits manager Caremark Rx Inc. for $21 billion, in a deal that will create a behemoth controlling the dispensing of one billion prescriptions a year -- more than a quarter of the U.S. total.

The combined company would have $75 billion in annual revenue, far higher than any competitor in drug retailing or the business of administering prescription health-insurance benefits for employers.

Caremark CEO Mac Crawford and CVS CEO Thomas Ryan discuss their recent merger, why the deal makes sense and the impact Wal-Mart's generic-pricing program is having on the playing field.

The companies promised the combination would lead to new services and efficiencies that would lower drug prices and improve returns to shareholders. Skeptics said that the deal represented a reduction in competition that would lead to higher prices at a time of continuing concern over rising health-care costs. And the stocks of both companies dropped yesterday.

The deal is expected to get a tough review by the Federal Trade Commission, and could face forced changes or divestitures if the agency finds antitrust problems. An FTC spokeswoman declined to comment.

Analysts said the deal could lead to further consolidation among drug retailers and pharmacy-benefit managers. The so-called PBMs have placed pressure on drugstores by negotiating for lower prices on behalf of their clients and via mail-order plans that compete for prescription business.

CVS, which already owns a smaller PBM, has vied in recent years with Walgreen Co. for the No. 1 spot in drug retailing with Walgreen leading in sales and CVS in number of stores. And Caremark has run neck-and-neck with Medco Health Solutions Inc. The combined company could realize strategic benefits over both its archrivals. CVS and Caremark said they would gain $400 million in "operating synergies" -- increased purchasing power and cost savings -- via the deal. CVS could also use its retailing leverage to run promotions on items like beauty aids at its 6,200 outlets to attract new PBM clients. Conversely, Caremark has tens of millions of members, translating into a potential windfall of new foot traffic to CVS stores.

"What Caremark gets is access to a new approach" to pharmacy benefits, said David Veal, an analyst at Morgan Stanley. He cited CVS's recent deal with car maker DaimlerChrysler. CVS's small PBM, PharmaCare, won the car maker's business in part by offering 20% discounts to DaimlerChrysler employees on CVS private-label products in its stores.

With an increasing number of Americans opting for mail-order prescriptions, which have been pushed by companies like Caremark, the acquisition gives CVS a stronger position than its drugstore rivals. Mail-order prescriptions have been highly profitable for the PBMs since they can dispense prescriptions more cheaply from highly automated mail facilities.

In recent years, PBMs have convinced many employers, like General Motors Corp. and International Business Machines Corp., to implement "mandatory mail" programs, which have forced millions of customers to get their medicines in the mail rather than in retail stores. Although the growth rate of mail order has slowed recently, it still outpaces that of the retail drug sector. According to IMS Health, a health-information service, about $36.9 billion of prescription drugs were bought through the mail in 2005, a 7% increase from 2004. For drugstore chains, which had a bigger share of the market at $88.2 billion in sales, the sales increase was 5%.

By combining with the big benefits manager, CVS reaps the benefit no matter if a customer goes to one of its drugstores or opts to fill the prescription via mail. "If you are CVS and can own one of the biggest mail-order operations in the business, you become more agnostic on where the prescription can be filled," said John Ransom, an analyst with Raymond James.

What the deal means for consumers is less clear, with some warning the merger of the companies might result in higher drug prices or co-pays. "If CVS is getting into this because they think they can increase their profits by acquiring and controlling the PBM, it might be very good for CVS, but it's hard to imagine how it is good for the public," said Sidney Wolf, the director of the health research group at Public Citizen, a Washington nonprofit group often critical of the drug industry. "There is no evidence this kind of thing passes money onto patients."

PBMs are not strangers to charges of conflicts of interest. Medco, Caremark's biggest rival, was owned by Merck & Co., until 2003. As a result, Merck drugs had a higher market share of users among Medco members than among other patients, even when there were less-expensive alternatives available.

Employer customers of Caremark "should be nervous and need to ask some questions," said Keith Bruhnsen, assistant director at the benefits office of the University of Michigan, a former client of Caremark's. "They're going to have to examine whether this is going to create some conflicts of interest."

Concerns about conflicts of interest or higher prices were dismissed by CVS Chief Executive Thomas Ryan and Caremark Chief Executive Edwin M. "Mac" Crawford during a joint interview. "Our job is to get the best price and stay competitive," Mr. Crawford said. "There is no way we can suddenly charge more money and not be competitive in the marketplace."

CVS's interest in the pharmacy-benefits management business isn't new. The company bumped up the size of PharmaCare in 2004 when it acquired the PBM business of Eckerd drugstores as part of an acquisition that included the purchase of about 1,000 Eckerd stores, mainly in Florida and Texas. PharmaCare reported revenue of $3 billion last year, making it the fourth-largest benefits manager in the country, according to CVS.

The companies said it would take six months to a year to close the deal, under which Caremark holders would get 1.67 CVS shares for each Caremark share. Billed as a "merger of equals," the company, to be called CVS/Caremark, will be based in Woonsocket, R.I., where CVS is located. Its PBM business would be located in Nashville, Tenn., where Caremark has its headquarters. Mr. Crawford will be chairman; Mr. Ryan will be the chief executive. The board will be split equally between Caremark and CVS representatives.

Investors reacted harshly to the deal, largely because CVS was offering only a narrow premium of about $3 a share, using Monday's closing prices of the stocks. Yesterday, CVS shares closed down $2.32, or 7.4%, to $29.06 as of 4 p.m. in New York Stock Exchange composite trading. Based on that price, the deal would be valued at $20.9 billion. Caremark shares were down $1.46, or 2%, to $48.17 in Big Board trading.

Drugstore and PBM stocks have been under pressure. Both sectors declined after Wal-Mart Stores Inc. said in September that it would charge $4 for a 30-day prescription of certain generic drugs at stores in the Tampa, Fla. area. Wal-Mart quickly expanded that program to stores in 27 states.

Another factor pressing on PBMs and retailers recently has been a looming cut in branded-drug list prices, prompted by industry litigation. The list prices are used as benchmarks for reimbursing PBMs and drugstores and the potential reduction is expected by some analysts to lower their revenues and profits.

Mr. Ryan said the actions of Wal-Mart "were never part of the equation" in merging with Caremark.

CVS competitor Walgreen already operates a PBM, called Walgreens Health Initiatives. However, in August it lost its major corporate client: Ovations, the senior health-care unit of UnitedHealth Group Inc. Walgreen had been handling Medicare Part D prescriptions for Ovations, but UnitedHealth decided to bring the processing in-house.

Michael Polzin, a Walgreen spokesman, said the company plans to grow its PBM business, but he wouldn't address whether it will make any acquisitions.