CVS Caremark (NYSE:CVS) and Cardinal Health (NYSE:CAH) announced a 50/50 joint venture last week to form the largest generic-sourcing vehicle in the U.S. The strategic alliance will enhance each outfit's leadership position in generic-drug distribution and sales while enhancing value for customers, clients, and shareholders.
The joint venture at a glance
The companies have agreed to combine their sourcing and supply chain expertise in the distribution of generic drugs to form this partnership. The companies expect the venture to be up and running by July 1, 2014.
According to the press release, the agreement has an initial term of 10 years. Furthermore, the agreement requires Cardinal Health to make quarterly payments of $25 million during the term to CVS Caremark (an estimated after-tax present value of $435 million). Finally, the companies also separately announced a three-year extension through June 2019 of other drug-distribution agreements.
CVS Caremark's CEO Larry J. Merlo said of the deal, "[It] will enable us to maintain our leadership role in navigating the dynamic U.S. generics market. With its combined volume and capabilities, the joint venture will develop innovative purchasing strategies with generic manufacturers and enhance supply chain efficiencies."
Why it matters
The motive for this deal is simple. The U.S. market for medicines has shifted toward more affordable generic drugs after a number of recent patent expirations for major brand names. And with the implementation of the Affordable Care Act, this move will be part of a growing effort to lower costs for generic drugs.
The joint venture will strengthen CVS Caremark's position in generic-drug sales and support long-term earnings. The contemplated agreement is also inline with other similar deals between distributors and retail-pharmacy chains. So this allows Cardinal Health to keep pace with its competitors.
The alliance is designed to enable the partners to develop more efficient and cost effective purchasing strategies with generic manufacturers. In short, this venture will allow each outfit to maintain its lead roles in the distribution of generic drugs while reining in the costs of generic drugs for consumers and thereby creating value for investors.
More importantly, CVS Caremark will also have a good opportunity to challenge its rival pharmacy-benefit managers, or PBMs, like Express Scripts (NASDAQ:ESRX). The company operates as a third-party administrator of employee drug plans and about 100 million members receive their prescriptions from a plan managed by this PBM. Moreover, Express Scripts delivers a heavy dose of prescription meds to its customers.
The company also has a large share of the Medicare prescription market and its business model is designed to cut out-of-pocket costs for generics. These factors make Express Scripts the largest PBM.
So, the CVS Caremark/Cardinal Health deal will give CVS Caremark better footing if not a competitive advantage over Express Scripts. Also, the joint venture with Cardinal Health will support long-term earnings growth by way of the $25 million quarterly payments for 10 years.
Finally, this agreement comes on the heels of another good move by CVS Caremark with its recently announced acquisition of Coram Infusion from Apria Healthcare Group. Coram Infusion provides specialty infusion therapies and nutrition services. CVS Caremark believes this deal will also support long-term earnings. The transaction will also allow CVS Caremark to expand its development of in-store mini-clinics, a service where Walgreen has the edge.
The bottom line
The CVS Caremark/Cardinal Health arrangement is part of CVS Caremark's broader strategy of growing by way of acquisitions and strategic alliances. CVS Caremark is already the leader in generic-drug sales and in recent years it has expanded its in-store offerings by selling more consumables. The company's business model is designed to gain market share from its key competitors like Walgreen, Express Scripts, and other retail pharmacies.
The partnership with Cardinal Health is aimed at lowering the cost of generic drugs, and this will not only benefit the partners but consumers and investors as well. Earlier this year, CVS Caremark's shares were trading at about $51 and currently hover at $68.
In sum, CVS Caremark continues to position itself as a good long-term investment by diversifying its retail offerings with more mini-clinics, enhancing its prescription sales of generics, and ensuring income streams to support earnings growth. In the final analysis, CVS Caremark's joint venture with Cardinal Health is another good deal for the leading retail pharmacy.
Kyle Colona has no position in any stocks mentioned. The Motley Fool recommends Express Scripts. The Motley Fool owns shares of Express Scripts. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.