A CVS Breakup Is No Easy Fix for Its Problems
Splitting up the company would face challenges, but there is no perfect solution to its struggles
In recent years, CVS Health CVS -2.13%decrease; red down pointing triangle has sought to transform itself from a retail pharmacy chain to a health conglomerate combining everything from the doctor to the insurer under one roof. It might still have a shot at building a health juggernaut, but perhaps without the well-known pharmacy that brought everything together.
CVS is considering a breakup and other strategic alternatives as pressure from investors builds on management in the midst of disappointing earnings results and a depressed stock. Over the past five years, its stock is basically unchanged, compared with a near doubling of the S&P 500. On Monday, the hedge fund Glenview Capital Management met with CVS to discuss ways to improve operations, The Wall Street Journal reported.
Separating the pieces would be complicated because it would risk taking away certain benefits that the units enjoy from being integrated. What to do with the pharmacy benefit management business Caremark would be the most difficult question because it is complementary to both the insurance and the pharmacy sides. For that reason, it is far from clear that a breakup will actually happen. CVS shares fell 2.1% on Tuesday after news that a breakup was being considered.
If the company does pursue a split, a key advantage would be focus and simplicity. What a breakup would look like hasn’t been outlined, but it is safe to assume that the goal would be to separate the structurally challenged retail pharmacy stores from the more profitable insurance business, Aetna. While Aetna’s Medicare business has been struggling lately, its performance could improve as some near-term cost drivers subside. The retail chain, on the other hand, would be harder to turn around, as evidenced by the bankruptcy of Rite Aid, the struggles of Walgreens Boots Alliance, and pharmacy closures across the country.
If Aetna were to break off along with the pharmacy benefit manager business, it would end up looking similar to Cigna Group, an insurer with a large PBM. Since the Cigna-like company would be more focused, without the financial headwinds attached to the retail pharmacy, it could arguably fetch a better multiple from investors. Cigna’s forward price/earnings multiple is 11.3, compared with 8.5 for CVS. An even more favorable comparison might be Humana, a Medicare-focused company with a smaller PBM, which fetches a 15.7 multiple.
Aetna might not be quite as attractive as Cigna or Humana right now, but the point is that standing alone would untether it from the problems in the pharmacy space.
The bigger question is whether a vertically integrated health company really needs a retailer that sells such items as foot cream and potato chips. Synergies between pharmacies and other healthcare services might not be as great as some had hoped. Walmart and Walgreens have both been pulling back from primary care recently after finding out how challenging it is to make money in clinics.
In recent years, CVS tried to grow beyond its roots by attempting to chart a course similar to that of UnitedHealth Group, the large healthcare organization with thousands of doctors, a pharmacy benefit manager business and an insurance arm. CVS acquired Aetna for nearly $70 billion in 2018. More recently it acquired Oak Street Health, a primary-care doctor chain, for $10.6 billion, and Signify Health, a home-care provider, for $8 billion.
The strategy of bringing together insurance and medical care requires careful execution and expertise. “If you put a V-8 engine in your car, it doesn’t automatically make it a Ferrari,” says Justin Simon, a portfolio manager at the healthcare hedge fund Jasper Capital Management. “You need to fine-tune ways to drive synergies between owning doctors and an insurer.”
A breakup, however messy, would allow the company to separate the intractable problem of how to fix the retail pharmacy from the more appealing, but still challenging, job of building a vertically integrated health company.
The architects of the breakup could look to clean up the insurance business by leaving a lot of debt with the retail pharmacy entity, Simon argues. That would leave the other company looking a lot more like Walgreens, a troubled company in its own right. But the argument is that the sum of two separate entities would lead to more value being created for investors than what the integrated CVS has been able to deliver.
There isn’t a straightforward answer for CVS. It could yet find a way to extract value from its disparate businesses while they stay together. But after so many years of struggles, it is clear that something significant needs to happen to give the company a new direction.