CVS Blazes a New Healthcare Trail

Retail drugstore firm CVS (NYSE: CVS  ) has never been afraid to acquire competitors to supplement its internal growth prospects. While yesterday's third-quarter results included what investors have come to expect -- strong retail growth with a couple of modest acquisitions -- they were hit over the head with an announced deal that few could have imagined.

Third-quarter results
First, a recap of the third quarter. Net sales advanced 24.9% to $11.2 billion and same-store sales grew an impressive 9.1%. This was made up of pharmacy comps of 10.2% and front-end (general merchandise sales of groceries, snacks, and toiletries) comps of 6.4%. It should be noted that the same-store figures did not include stores acquired from Albertson's, although total sales numbers included the addition of the 701 Sav-on and Osco stores.

The drugstore acquisitions shaved about $0.05 off third-quarter earnings, but were still able to grow 12.5% to $0.33 per diluted share. In short, CVS reported another steady, predictable quarter, continuing its reputation for successfully pursuing acquisitions to enhance organic, or internal, growth.

An unexpected announcement
Now, fasten your seatbelts. CVS' steady-eddy reputation will soon be tested, as CVS also announced it will merge with PBM (pharmacy benefit manager), Caremark (NYSE: CMX  ) , to create a $75 billion prescription behemoth based on total sales. For Fools not overly familiar with PBMs, they use their clout to negotiate drug prices with large drug firms and provide cost-effective ways for customers to fill prescriptions under their healthcare plans. It sounds confusing and gets even more so once government programs such as Medicare for the elderly are added to the mix, but it's basically a system drug makers can use to get their products in the hands of the end user.

Possible rationales for the marriage
So why would CVS move out of retail and purchase one of the largest PBMs? Well, the market is still trying to figure that out, but it's likely that the two companies are seeking to gain scale, believing they can further increase their clout by both filling prescriptions for inidividual consumers and serving the largest health-care organizations.

Before the acquisition, CVS already had its own small PBM called PharmaCare, and archrival Walgreen (NYSE: WAG  ) has also been building its own PBM. Retailers have clearly become concerned that the market for filling prescriptions through nontraditional avenues -- such as the Internet -- may eventually threaten their retail pharmacies.

Another possibility is that CVS and Caremark both freaked out when retailing behemoth Wal-Mart (NYSE: WMT  ) announced it would be selling hundreds of generic drugs for a mere $4 a month, causing consumers to flock to its stores to have their prescriptions filled for a lower cost.

Fool's final word
At the very least, both firms deserve credit for marrying one of the largest drug retailers with one of the largest PBMs. The market is skeptical and sent both stocks down after the merger announcement, as there is obviously a lot of uncertainty right now. While both firms fill prescriptions for a living, there could be synergies in combining both operating models, but it's still not certain if the combination will benefit shareholders, consumers, or both.

Without a crystal ball, it's hard to tell exactly how the industry will shake out, but the next several months will surely be interesting. CVS and Caremark will immediately start combining their operations, while retailers like Walgreen and PBMs like Medco (NYSE: MHS  ) will either consider pursuing their own mergers or decide to go it alone. For CVS and Caremark, the best place to view the developments may be on the sidelines. Once the merger is completed, however, the potential exists for a new paradigm in the drug distribution industry.

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Fool contributor Ryan Fuhrmann is long shares of Walgreen, but has no financial interest in any other company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to further discuss any companies mentioned.


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