It seems that big box retailer Target (NYSE:TGT) and pharmacy giant CVS (NYSE:CVS) keep moving closer and closer to each other in ways that may eventually lead to a merger. CVS is now the pharmacy and clinic operator at Target stores, and a deal announced this week will have Target's Shipt subsidiary delivering prescriptions from CVS across the country.
It wasn't long ago that CVS moved away from Target by spending $1.9 billion to buy Target pharmacies. But ever since, the two companies have been linked by growing partnerships and strategies that seem to be overlapping. Maybe a merger is the next logical step for both.
Joined at the hip
If we just step back and look at what Target and CVS are doing together today, it's clear that they're important partners for each other. CVS is located in Target stores, sometimes with both a pharmacy and a clinic. This helps both companies: Target can benefit from CVS's negotiating power with clinics and insurers, and offer better services to its customers. For CVS, meanwhile, having a wider footprint makes it an important partner for insurers and a convenient place for customers to buy drugs.
The CVS-Shipt agreement could deepen that relationship further. CVS might not be able to build physical drug delivery infrastructure on its own, but leveraging both Target stores and the CVS pharmacies inside them could make the Shipt deal a win-win agreement. And it could help Shipt reach a new demographic of customers.
Where I think strategies are really converging is in Target's small-format stores. Walking through a small format store, you'd think you were in a CVS if it weren't for the fresh produce and Target branding. The CVS pharmacy is there, and small-format Targets often overlap with similarly located urban CVS stores. Instead of opening 30 small format stores each year, Target could just leverage CVS's existing infrastructure.
Take all of the factors I outlined above, and I think both Target and CVS could be better off together. They could leverage CVS's more urban locations to grow Target's business in urban areas, and Target could make CVS's pharmaceuticals a key offering to Red Card and delivery customers.
The deal could also give the two companies more operating leverage in stores and improve margins. With earnings stagnant, at best, that may be attractive for both companies.
Assuming the two companies merge, it wouldn't quite be a merger of equals given CVS's larger size, but an all-stock deal could make sense. That way debt wouldn't weigh down the acquiring company, a burden neither should want to take on given the volatile results of the last few years.
Surviving in a changing retail environment
Both Target and CVS face their own challenges adapting to the realities of today's retail environment, and I think both would come out better with the benefit of the other. Target's delivery and pickup innovations would fit well with CVS's products, and CVS's locations are where Target is investing in its own growth. Merging the two operations into one could be beneficial to both, helping them combat the threats they face from nimble online retailers every day.