When CVS Health said last week it would spin off its 9,000 drugstores, nobody cheered.
Critics of healthcare consolidation called it a political decoy that leaves the conflicts of vertical integration at the insurance conglomerate untouched. Wall Street had a different gripe: the pieces might be worth less apart. The stock lost some $15 billion in market value when the breakup was announced.
But selling pills and sunscreen out of labor-intensive stores is a very different business from managing drug benefits at Caremark, insuring patients at Aetna or dispensing specialty drugs. And the strategic advantages of owning those stores have diminished. If they no longer give the rest of CVS a meaningful edge, splitting them up might leave investors better off -- even if it does nothing to appease lawmakers.
Breakups have become increasingly popular on Wall Street. The argument for them is often that they sharpen management's focus and allow faster-growing businesses to command higher valuations. To skeptics, though, the CVS breakup looked like a retreat under regulatory fire. The company announced it with almost no financial detail. CVS didn't say how it would divide its $60 billion of debt or how much it would cost the two businesses to operate separately.
Investors assumed the worst. Some feared the lost benefits of common ownership -- lost synergies, in Wall Street parlance -- could top $1 billion a year. At a Wolfe Research investor conference this week, CVS Chief Executive David Joyner said an analyst's estimate of about $500 million a year was "much closer" to CVS's own models. That helped lift the shares, though they are still trading slightly below where they stood before the Nov. 4 announcement. Whether existing contracts between the stores and pharmacy-benefit manager Caremark stay in place over the long term is another matter.
More important is the strategic logic of the split. Regulation has steadily eroded the advantages of owning drugstores, Joyner said in an interview. Caremark's benefit designs once drew members to CVS counters, but many states have moved to restrict such arrangements, and some have moved to ban common ownership of pharmacies and pharmacy-benefit managers, or PBMs, outright. So why keep a capital-intensive, slow-growing political headache?
Specialty pharmacy is a different story. These pharmacies handle expensive drugs for complex conditions such as cancer and multiple sclerosis. These are often injectables that need special handling and can cost tens of thousands of dollars a year. Joyner says pairing CVS specialty pharmacies with the PBM still pays off, and that state lawmakers have mostly gone after PBMs that own retail pharmacies, not specialty ones.
There is a simpler financial logic, too. Investors value store chains and managed care operators very differently. Once apart, each can be judged, and run, on its own terms.
CVS's pitch is that a company focused on the faster growing parts of the healthcare system will receive a much higher multiple and lose the conglomerate discount. The skeptics aren't so sure. They value the stores like Walgreens, the struggling drugstore chain taken private last year at six to seven times enterprise value to earnings before interest, tax, depreciation and amortization. And they see the rest of CVS as another Cigna, which also owns an insurer, a PBM and a specialty pharmacy, and trades at about 9 to 10 times expected earnings. At about 10 times next year's expected earnings, CVS is already priced much like Cigna.
But that comparison may not be entirely fair. Cigna's insurance arm mostly covers employer plans. Aetna has the country's third-largest Medicare Advantage business and the largest specialty pharmacy. Joyner argues that makes CVS Health more comparable to UnitedHealth, which trades at roughly 18 times expected earnings. Medicare Advantage has historically earned insurers a premium valuation, and it is driving CVS's earnings recovery this year. So the case for a higher multiple hinges on Aetna's Medicare business continuing to improve, which is as much a political question as a financial one.
The drugstores probably deserve a bit better valuation than Walgreens, too. Retail pharmacy is a tough business, but CVS has more scale, and with rivals closing hundreds of stores, there is less competition than there used to be. Profits are growing: adjusted operating income at the stores rose about 11% last quarter, helped by Rite Aid prescriptions and locations CVS bought last year.
The bigger problem for CVS, and for the rest of the healthcare conglomerates, is that healthcare costs aren't going away as a political issue. And CVS is keeping the businesses that critics find most troubling. Caremark will still be able to send patients to CVS's own specialty pharmacies.
That is where the money is. As Joyner himself notes, the roughly 2% of patients taking specialty drugs account for about half of all drug spending. Critics argue that when a PBM decides which drugs qualify as specialty and then fills those prescriptions at its own pharmacy, it can mark them up. A bipartisan bill from Sens. Elizabeth Warren (D., Mass.) and Josh Hawley (R., Mo.) that would force PBM owners to sell their pharmacies, specialty ones included, is unlikely to advance soon. But the pressure isn't going away, and could some day mean a broader breakup.
Spinning off the stores won't get Washington off CVS's back. It could still be the best move for shareholders.