A deal that was months in the making is finally official, with Aetna's board of directors approving on Sunday the health insurer’s sale to drugstore chain operator CVS Health Corp for approximately $207 per share in cash and stock, in a deal worth $67 billion, multiple news sources reported on Sunday afternoon. The purchase price represents a premium of 29% to where Aetna shares were trading before the WSJ first reported that the two companies were in talks in October.
The deal will be this year’s largest corporate acquisition, and in combining one of the nation’s largest pharmacy benefits managers (PBMs) and pharmacy operators with one of its oldest health insurers, will "reshape health care" by bringing a large insurer and a big provider of pharmacy services under one roof.
According to the agreed terms of the deal, which will be announced later on Sunday, Aetna shareholders will receive $145 per share in cash and 0.8378 CVS Health shares for each Aetna share. According to Reuters, "Aetna shareholders will own about 22% of the combined company, while CVS shareholders will own the remainder." As part of the acquisition, three Aetna directors, including Aetna’s Chairman and CEO Mark Bertolini, will join CVS’s board of directors. After the deal closes, Aetna will operate as a separate unit run by members of the current management.
The acquisition will be financed with a mix of cash and debt. Barclays, Goldman Sachs and Bank of America have committed to provide $49 billion of financing, Bloomberg reported.
With Aetna currently employing 49,500 while CVS has 204,000 full and part-time employees, the combined company will boast a quarter million workers, if only for the time being. The deal, which is expected to close in the second half of 2018, will create cost savings of about $750 million, which means tens of thousands of layoffs.
Some more on the companies' background: CVS, with annual revenue of $178 billion, is a major pharmacy-benefits manager in addition to its vast collection of drugstores, some of which already have retail clinics. Aetna, with revenue of around $63 billion, is the third-largest U.S. health insurer, providing coverage to around 22.2 million members enrolled in employer, Medicare, Medicaid and other plans.
The deal comes as healthcare payers and pharmacies are responding to rapidly changing factors, including Obamacare, rising drug prices "and the threat of competition from online retailers such as Amazon.com", Reuters noted. In fact, as Morgan Stanley pointed out two weeks ago, Amazon's imminent entry into the healthcare sector has been cited as one of the primary catalysts behind the AET/CVS deal:
As a reminder, this is how Morgan Stanley summarized the rationale behind the just announced merger:
Drug retailers have the most opportunities to adjust their business models and lower cost structures to defend against Amazon. Within the drug supply chain, the threat of Amazon’s entry into drug retail is accelerating vertical integration, and is cited as a driver behind the rumored CVS/Aetna merger. In our view, the combination would diversify profits away from the supply chain, help create a narrow preferred network, and act as a first step in repurposing the retail footprint to create a new healthcare-retail delivery model. If drug retailers don't change this model, we estimate ~10% risk to profits. CVS has also announced free same-day delivery in New York City, proactively preparing for a potential Prime Now entry, in our view.
As a result, the deal “feels more defense than offense,” Ana Gupte, an analyst with Leerink Partners LLC, said recently. In Aetna’s case, “I don’t see a path to growth” in its current configuration, she said.
“One of the problems with the health-care system is it’s so fragmented and there’s so little coordination,” Bessemer Ventures' Steve Kraus told Bloomberg. “A better vertically integrated less-siloed system is a good thing in my mind.”
In this context, Reuters points out that CVS plans to use its low-cost clinics to eventually save more than $1 billion per year on health care costs for Aetna’s roughly 23 million medical members. It adds that a combined insurer and PBM will also likely be better placed to negotiate lower drug prices, and the arrangement could boost sales for CVS’s front-of-store retail business.
It's not just imminent layoffs however, as the combined company expects to invest billions in the coming years to add clinics and services, largely financed by diverting funds away from other planned investments.
That could eventually cut costs substantially, with the clinics serving as an alternative to more expensive hospital emergency room visits.
Meanwhile, deeper collaboration between Aetna’s insurance business and CVS’s PBM division could drive down drug costs by adding clients and boosting the PBM’s leverage with drugmakers.
In recent years, independent PBMs have been criticized for keeping drug prices high amid potential conflicts of interest with insurance company clients, because they could potentially keep cost savings from drug negotiations rather than passing them on to patients.
Alternatively, PBM margins have been pressured and health insurers have sought to cut costs amid steep prescription drug price rises and requirements to care for even the sickest patients under the Affordable Care Act.
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Analysts cited by Reuters said the CVS-Aetna deal could prompt other healthcare sector mega-mergers, as rivals scramble to emulate the strategy.
It could spur a merger between Walgreens Boots Alliance Inc and Humana Inc, or between Humana and Wal-Mart Stores Inc, Ana Gupte, analyst at Leerink Partners, said recently.
On Nov. 30, Express Scripts Holding Co.’s top executive said the company would be open to a deal at the right price, though wasn’t actively looking for one. “We don’t need to sell to be very successful in the future, but we are always open to others who may all of sudden conclude they want what we have,” Express Scripts CEO Tim Wentworth said in an interview. He also mentioned the possibility of partnering with Amazon on a drug distribution arrangement.
The deal, and any subsequent follow through, is not without risk of regulatory intervention: last year Aetna tried to buy rival Humana Inc to gain leverage to control costs, but antitrust regulators killed the deal as well as a proposed merger between Anthem and Cigna. Furthermore it is unclear if the DOJ, which recently sued to block the Time Warner-AT&T deal, won't issue another antitrust veto. That could happen if the DOJ shifts its attention to vertical mergers:
Although CVS and Aetna’s planned merger does not directly consolidate the health insurance or pharmaceutical industries, the U.S. Department of Justice has been taking a closer look at so-called vertical mergers, where the companies are not direct competitors.
Last month, the Justice Department sued to block AT&T Inc’s planned $85.4 billion merger with Time Warner Inc, saying the integration of a content producer with a distributor could reduce consumer choice.
Reuters concedes that "the CVS-Aetna deal could attract similar scrutiny if regulators feared it could block Aetna customers from frequenting other pharmacies or contracting with other PBMs" even as four antitrust experts said there is little doubt the deal will be approved, although it might need to meet conditions to convince antitrust enforcers to sign off.
It is unclear whether it would be evaluated by the U.S. Federal Trade Commission or the Justice Department but that decision might be made based on which agency is less busy, said Matthew Cantor of law firm Constantine Cannon.
“(The companies) want the FTC to get it. The reason that the FTC is better at this point is that the Justice Department has just broken with decades of precedent of how to deal with vertical mergers,” said Cantor, referring to the decision to refuse conduct remedies and file a lawsuit to stop AT&T from buying Time Warner.
According to Bloomberg Intelligence's Jennifer Rie, the CVS-Aetna deal antitrust prospects may depend on which U.S. regulator is tasked with reviewing it.
The Federal Trade Commission has been less critical of consolidation among companies in adjacent businesses, known as vertical consolidation. The Justice Department, on the other hand, last month sued to block the merger of AT&T Inc. and Time Warner Inc., a vertical deal.
Michael Newshel, an analyst at Evercore ISI, said the DOJ effort to block the AT&T-Time Warner deal does raises concerns but a CVS-Aetna deal does have a path forward. Aetna would likely need to divest some or all of its Medicare drug plan business, he said.
In addition to regulatory risk, the combination faces substantial challenges, "including the huge operational task of knitting together the companies’ diverse operations so that customer experiences are smooth and seamless. The deal isn’t likely to deliver as many cost-cutting benefits as combinations with more direct overlap, such as Aetna’s scuttled acquisition of Humana, analysts said. CVS will need to keep much of Aetna’s infrastructure since it doesn’t currently provide health insurance."
As noted by the WSJ, as part of the deal CVS plans to repurpose portions of its pharmacies so they become community health centers where customers can go to get answers to more questions about their health and coverage and how to manage the cost of it. The pharmacies will have space dedicated to wellness, and provide services for things like vision, hearing and nutrition.
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