Despite the fact that it brought in almost three times as much revenue as Nike last year, you probably haven't heard of CVS Caremark's (NYSE:CVS) "other" business -- the one that doesn't involve retail pharmacies on street corners, yet brought in the majority ($76 billion of $127 billion) of revenue last year.
That business, which operates under a handful of names including, most notably, Caremark, helps healthcare payers deliver prescriptions more cheaply to patients. Since CVS' pharmacy services business is relatively unknown among big national companies, let's take a closer look.
Connecting the dots
CVS' pharmacy services business is a pharmacy benefit manager, or PBM. Its clients include healthcare insurers and companies and organizations that self-insure employee healthcare plans.
The primary goal of PBMs is to save payers money. Much like a national footwear chain negotiates with Nike for the lowest price on its latest running shoe, PBMs leverage the buying power of many different companies to negotiate cut-rate deals with drugmakers.
Those deals allow insurers to deliver patients prescribed medicine for less than it would cost them if they negotiated with drugmakers directly; however, PBMs don't just orchestrate rock-bottom drug prices. They also provide other services including making sure patients use less-costly generics when they're available, mail order pharmacies which can deliver drugs at a lower cost, and management programs like Pharmacy Advisor, which helps ensure that plan members are adhering to their medication regiments, which can help reduce expensive hospitalizations.
Protecting its moat
In 2007, PBMs like Caremark, Express Scripts, and Catamaran were increasingly winning away prescriptions from pharmacies like CVS by delivering convenient, 90-day prescriptions directly to patient doors.
That threat helped prompt CVS to outbid rivals to acquire Caremark, one of the nation's largest PBMs.
The deal catapulted CVS forward; revenue jumped from $43 billion in 2006 to more than $132 billion over the trailing-12 months. CVS' operating profit has similarly climbed following the Caremark acquisition, growing from $2.4 billion in 2006 to $8 billion in 2013.
The cost of medicine is growing rapidly as new personalized drugs make their way through expensive clinical trials to market. This next generation of drugs aims to improve patient outcomes, but does so at a steep price.
Many new expensive drugs are coming to the market (think multiple sclerosis drugs Tecfidera and Gilenya), but it's Gilead's Sovaldi, an $84,000 treatment for hepatitis C that effectively cures more than 90% of patients taking it, that has become the poster child for the next generation of expensive medicine.
While these therapies are exciting, they are also straining insurers caught between public demands for low monthly insurance premiums and rising expenses tied to prescribing these treatments. As a result, payers are seeking out strategies that lower costs and PBMs are responding with a slate of solutions, including programs designed to improve patient health.
As a result, PBMs like CVS' Caremark business are at the forefront in the battle to deliver patients the medicine they need at a lower price.
Fool-worthy final thoughts
While PBMs like the one run by CVS would seem to be in the sweet spot of rising drug spending, they still face heady challenges.
Lowering costs for payers means that PBM profit margins are thin, particularly given that drugmakers remain eager to earn top dollar for their medicine and insurers are laser focused on improving their own bottom lines.
Having said that, the ability to reduce the cost of drugs is front and center given that 10,000 baby boomers are hitting 65 every day and those over 65 typically fill twice the number of scripts per year compared to those age 45 to 54 years. With soaring healthcare costs likely to continue to pressure payers, PBMs like the one run by CVS may prove to be winners if they can deliver savings that justify clients sticking with them.
Todd Campbell is long Gilead. Todd owns E.B. Capital Markets, LLC. E.B. Capital's clients may or may not have positions in the companies mentioned. Todd owns Gundalow Advisors, LLC. Gundalow's clients do not have positions in the companies mentioned. The Motley Fool recommends CVS Caremark and recommends and owns shares of Gilead Sciences. 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.