It's official. After a little over five weeks of speculation, CVS Health (CVS 3.47%) announced on Sunday that it was acquiring Aetna (AET) for $69 billion. The combination of the two companies will create a healthcare giant with a market cap of around $135 billion -- making CVS Health the seventh-largest healthcare company in the world.
But will bigger necessarily be better for CVS Health investors? Big deals make big headlines. However, they don't always turn out to be as great as their hype. In this case, as is often true with megadeals, there are both positives and negatives for investors.
CVS Health stated that shareholders can expect low- to mid-single digit earnings accretion in the second full year following the close of the acquisition. With 2017 turning out to be a big disappointment for investors, any possibility for earnings improvement has to be viewed as a positive for the company.
Probably the biggest positive for the deal, though, is the potential that the integration of the two organizations could bring for long-term growth. This would be the first combination of a large pharmacy retailer, pharmacy benefits manager (PBM), and major health insurer. It's also important to remember that CVS Health has over 1,100 walk-in clinics in pharmacy stores across the nation.
CVS Health CEO Larry Merlo said that the deal "brings together the expertise of two great companies to remake the consumer healthcare experience." He added, "With the analytics of Aetna and CVS Health's human touch, we will create a healthcare platform built around individuals." Aetna CEO Mark Bertoloni stated that the combined companies "will better understand our members' health goals, guide them through the healthcare system and help them achieve their best health."
Admittedly, those are the kinds of things you'd expect Merlo and Bertoloni to say. However, they could be right. One of the factors behind high healthcare costs in the U.S. is the fragmentation of the system. This is especially problematic for the management of chronic care. It's not hard to envision how the post-acquisition entity could develop innovative new products that manage chronic care more effectively -- and increase revenue and earnings for CVS Health.
Another positive could come from minimizing a potential negative. Investors have worried about the damage that CVS Health and other major pharmacy chains could suffer if Amazon (AMZN -2.02%) enters the retail pharmacy market as expected. Stories began to make waves in May that the internet giant was eyeing the pharmacy space. Although some dismissed the threat, over the last few months it seems increasingly likely that Amazon will move forward.
Currently, retail and long-term care pharmacy accounts for more than 40% of total revenue. The addition of Aetna into the fold would diversify CVS Health's revenue and help cushion the impact of any potential impact from Amazon's entry into the pharmacy market.
What about the negatives of the CVS-Aetna deal? Let's start with debt. The actual price tag of the transaction is greater than $69 billion. CVS Health is also assuming roughly $8 billion of Aetna's debt. Add that to CVS Health's current debt of nearly $23.5 billion.
However, the debt picture will actually be worse. CVS Health is financing the Aetna acquisition through a combination of cash and debt financing. Considering that CVS only had around $2.5 billion in cash (including cash, cash equivalents, and short-term investments) at the end of September, it doesn't take a math genius to realize that the company's debt load is about to get much larger.
There's also the potential impact that the combination of the two companies could have on CVS Health's ability to work with other major insurers. Larry Merlo said on Monday morning that the deal won't impact CVS Health's agreement with Anthem (ELV 1.19%) to build its own PBM. However, it seems likely that further opportunities to partner closely with Aetna's rivals will be limited -- if not non-existent.
The buyout of Aetna must also be approved by federal regulators. So far this year, gaining a green light from the Federal Trade Commission (FTC) for major mergers and acquisitions hasn't been easy. And sometimes the FTC requires the acquiring company to give up part of its business to make a deal happen. We don't know yet if this will be the case for CVS Health. If it does happen, though, it could make the Aetna acquisition look less appealing than it does right now.
It's not surprising to me that CVS Health stock dropped Monday on news of the Aetna acquisition. Wall Street isn't convinced it's a smart move. Over the short run, I suspect they're right.
However, my view is that this deal could pay off for CVS Health and its shareholders over the long run. I'm not caught up in cost savings from a combination of the two companies. Those are fine, but to me the more important aspect of this deal is what the new CVS-Aetna organization could do to introduce new products and services to control healthcare costs. I think that over time, these innovations could make CVS Health a more vibrant business with faster growth than it otherwise would have had.