Writing a New Script
CVS and Caremark tout a revolution in drug selling
Investors in Caremark RX were left wondering last week how much they can bank on the wiles of Mac Crawford, the chairman who has earned plaudits for building the company into a leading drug benefits manager. Crawford surprised Wall Street by marrying up with CVS Corp., the stodgier retail drug chain, in a deal that sent shares in both companies down.
It's apparently a vision thing, with Crawford and CVS Chairman Tom Ryan buying into a picture of a healthcare juggernaut able to offer services that today are unprecedented and, unfortunately for them, hard for investors and consumers to envision. The companies plan to combine in a roughly $22 billion stock swap, giving Caremark shareholders a 45.5 percent stake in the new company, CVS/Caremark. "The combined company is going to change the way healthcare, and particularly pharmacy healthcare, is practiced in the country," Ryan told analysts in a conference call.
Middle ground. In the fast-growing business of managing drug benefits, Caremark has acted as a middleman between drug sellers, the pharmaceutical distributors like CVS, and consumers and the employers who help pay their drug costs. Crawford, who will be chairman of the new company, and Ryan, the CEO, emphasized the deal wasn't about cost savings. Instead, the upside is in the potential for new services, such as face-to-face help for patients managing long-term health problems.
"This behemoth will manage 1 billion prescriptions a year," says David Veal, a Morgan Stanley analyst, who likes the deal. A mere 1 percent shaved off drug prices would save Caremark $90 million, he notes. The companies project annual savings of $400 million, against revenues of $75 billion. And the company would be quite different: "The question is if the market is ready for it," Veal says.
The same question applies to Caremark's customers. Benefits managers are supposed to negotiate lower prices with suppliers like CVS on behalf of health plans, says Sean Brandle, a benefits consultant at Segal Co. "This removes one of the checks and balances in the system." Sharon Treat, a Maine politician who heads a group fighting for lower drug prices, says she couldn't imagine consumer benefits that would overcome "the inherent conflict of interest."
But consumers could quickly see a more efficient system if Caremark, which also arranges sales of cheaper drugs through mail order, can work more closely with a retailer like CVS, says Helen Darling, president of a business group focused on healthcare costs. No longer would consumers have to transfer a prescription from their local store to a mail-order service-it could be combined in one database. "Mergers like this enable companies to spend more on health information technology," she says.
Still, many analysts say Caremark sold itself too cheaply. "A combination now, on the promise of serving the consumer here, really doesn't make a whole lot of sense at these valuations," Bank of America Securities analyst Bob Willoughby told the execs. Willoughby predicts investors will revolt, scuttle the deal, and demand that Caremark disgorge more of its cash to them.
Others simply wondered if Crawford saw Caremark's run ending sooner rather than later, as competition heating up in the benefits arena-such as Wal-Mart's recent lowering of prices on many generic drugs-would push down margins.
Caremark "has generally been ahead of the curve strategically over time," wrote Merrill Lynch analyst Tom Gallucci. Caremark's investors and customers hope that is still the case.
The Gatekeepers
Pharmacy benefit managers have become a key cog in reshaping the nation's healthcare industry. Companies such as Medco, Caremark, and Express Scripts act as intermediaries on behalf of corporations, governments, and others, working with drugmakers to buy and distribute prescription medicines to individuals. One way they do this is through their mail-order prescription programs. By buying in bulk, they aim to reduce the cost of the drugs. They also maintain lists of drugs approved for certain medical conditions, while encouraging individuals to choose generic equivalents to the more expensive brand-name medicines. Collectively, the pharmacy benefit management industry processes prescriptions for more than 200 million people in the United States.
This story appears in the November 13, 2006 print edition of U.S. News & World Report.