Even for a leading company in its industry, the price is rich: CVS Health (NYSE:CVS) has agreed to acquire Omnicare (UNKNOWN:OCR.DL) for total consideration of $12.7 billion. That's more than double CVS's most recent annual net profit. Why is it willing to spend so much -- and is such a high amount really worth it?
A welcome deal
The deal will see CVS cough up cash for the entirety of the purchase price, which shakes out to $98 per Omnicare share. It's financing the deal through a short-term loan provided by Barclays.
Stockholders in both companies seemed to welcome the agreement, if the respective share price moves of the pair are any indication; Omnicare's stock closed 4% higher the day it was announced, while CVS' crept up by around 2%.
That $12.7 billion figure isn't entirely going toward buying the stock, though. It also includes the assumption of roughly $2.3 billion in Omnicare debt.
The boards of directors of both companies have approved the acquisition. It must also be ratified by Omnicare shareholders, as well as the appropriate regulators. Nevertheless, CVS Health said it expects to complete the buyout by the end of this year.
For Q1 2015, Omnicare's net sales came in at nearly $1.7 billion, a 6% increase from the same period of 2014. Net income saw a more dramatic rise of 21% over that time frame, to $77 million.
Buying a specialty
Omnicare's focus is the provision of pharmacy and related services for long-term medical care. The company is America's largest provider of these types of services for nursing homes and other elder-care facilities.
The company makes most of its coin in that segment, but its No. 2 business is growing significantly. This is the provision and administration of specialty drugs -- in other words, the pricier and more cutting-edge medications on the market.
The firm's specialty care group posted net sales of $465 million in Q1, 23% higher on a year over year basis. By comparison, the long-term care segment's nearly $1.2 billion in revenue was only 3% higher.
CVS found both parts of Omnicare attractive enough to pony up that nearly $13 billion. In a press release, the pharmacy giant said that owning Omnicare "will significantly expand its ability to dispense prescriptions in assisted living and long term care facilities, serving the senior patient population. CVS Health will also expand its presence in the rapidly growing specialty pharmacy business."
The deal fits very well into CVS' current business model. Although known to most Americans as a chain of pharmacies, the firm is actually growing its business largely through the provision of a related service: pharmacy benefits management.
The name gives away the game: PBM is a service in which the processing of drug prescriptions (typically for insurance firms or large corporations) is handled by a third party. This entity typically charges fees for its work, and it's expected to deliver cost savings through relationships with drug companies and pharmacies.
The obvious advantage CVS has in this segment is that it's a large pharmacy itself, thus it can leverage its relationships with drugmakers into lower prices for their goods.
PBM has lately been the motor driving up CVS' results. In the company's Q1, the segment's revenue grew by over 18%, and was responsible for most of the $36 billion in total top line. Although the company's retail pharmacy business grew too, there was no comparison; it rose 3% over the Q1 2014 result.
Omnicare must have been an irresistible takeover target for CVS, with not one but two segments that can beautifully augment the latter's activities. It was a pricey acquisition, but good potential rarely comes cheap. The deal should be considered a smart move for CVS that expands its business in the right direction.
Eric Volkman has no position in any stocks mentioned. The Motley Fool recommends CVS Health. 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.