Deal Overview
CVS Health (NYSE: CVS, $67.46, Market Capitalization: $84.86 billion), a leading health solutions company in the US, is considering a potential break-up to separate its retail and insurance units. As per media articles on October 07, 2024, management has been discussing various options with its financial advisers in recent weeks and said the possibility of splitting the pharmacy chain from the insurance business – Aetna has been discussed with the board of directors.
CVS Health completed its acquisition of Aetna on November 28, 2018, valued at approximately $69 billion to create a more integrated healthcare model by combining its pharmacy services with Aetna’s insurance capabilities. The company has also been evaluating whether its pharmacy benefits manager unit, CVS Caremark, which manages drug benefits for health plans, should be housed within the retail unit or under insurance if it were to proceed with a separation that could result in two publicly traded companies.
Post-separation, CVS Health (RemainCo) will primarily operate in the Retail Pharmacy, Health Services and Primary Care segments. Retail Pharmacy includes an extensive network of retail pharmacies which provide prescription medications, over-the-counter drugs and health and wellness products. Health Services encompass CVS’s pharmacy benefits manager (Caremark), specialty pharmacy services, and other health services under Oak Street Health, Signify Health, and Cordavis. Primary Care includes instore clinics and virtual care options. On the other hand, Aetna would become an independent, publicly traded company separate from CVS Health’s retail and pharmacy operations. This would allow Aetna to focus solely on its insurance products and services.
There is no official announcement about the separation as the company is undertaking a strategic review to explore various options, including a potential breakup.
Deal Rationale
CVS Health Corporation is a leading health solutions company in the US in terms of prescription drug revenue, holding more than 25% of the market share in 2023. It currently operates over 9,000 retail stores and 204 primary care medical clinics. The reportable operating segments include Health Care Benefits (HCB), Health Services, Pharmacy & Consumer Wellness and Corporate/Other.
CVS is exploring options to separate its retail pharmacy and insurance units. The insurance operations of CVS Health are primarily operated through its subsidiary, Aetna, which falls under the HCB segment. The company acquired Aetna, a health insurance provider, for $69.0 billion in 2018 to create a new healthcare giant by integrating the insurance business with its retail pharmacy, pharmacy benefit manager (PBM) – Caremark, and care provider services business. CVS Caremark is the pharmacy benefit management (PBM) subsidiary of CVS Health, which provides prescription benefit management, mail order pharmacy, and specialty pharmacy services, under the Health Services segment.
As per media articles, the healthcare services company is looking for a structural turnaround amid pressure from some of its major investors, such as Glenview Capital. A key focus of the breakup effort appears to be the underperformance of Aetna in the form of lower margins and higher operational costs, as well as increased government scrutiny on Caremark. The underperformance in the Aetna segment drove a leadership change earlier this year, with CEO Karen Lynch assuming direct oversight of the company’s insurance unit in August, displacing then-President Brian Kane.
Aetna offers various health insurance plans, including employer-sponsored plans, individual and family plans under the Affordable Care Act (ACA), Medicare Advantage (MA) plans, and Medicaid services. The MA plan, which provides comprehensive health coverage to seniors has been facing challenges due to rising medical costs. For example, a rise in hip and knee surgeries, medical services related to the eyes, dental work and vaccinations, including the RSV shot, drove up costs in CVS’s Aetna MA plans, impacting its margins. For 1H24, the HCB segment’s adjusted (Adj.) operating margin declined to 2.6% versus 6.4% in 1H23. The insurance unit’s medical benefit ratio (a measure of total medical expenses paid relative to premiums collected) increased to 90.8% in September 2024 from 88.5% in September 2023. As a result, CVS lowered its adjusted profit forecast for 2024 (annual profit forecast of $6.40- $6.65 per share, from at least $7.00 per share previously) for the third time this year. Management expects the costs from this plan to continue to rise due to higher operating costs post-Covid.
Aetna’s ratings have experienced significant fluctuations over the past few years. For the 2022 plan year, 76.0% of Aetna’s MA members were in plans rated four stars or higher. However, this figure dropped sharply to just 21.0% in 2023, creating a major headwind for the company. This decline meant Aetna did not qualify for the same level of quality bonus payments from the Centres for Medicare & Medicaid Services (CMS), resulting in an estimated loss of between $800.0 million and $1.0 billion in operating income for FY24. To counter this headwind, Aetna implemented several strategic initiatives, such as enhancing member experience, improving medication adherence, and strengthening care management programs. These efforts seem to have paid off, with the percentage of members in four star or higher plans rising to 87.0% for the 2024 plan year and 88.0% for 2025. As a result, Aetna is now likely to receive a 5% bonus on its monthly per-member payments from CMS, which could significantly boost their financial performance.
The PBM segment is also under scrutiny following a lawsuit filed by the Federal Trade Commission (FTC) against CVS Caremark. The FTC alleges that CVS Caremark, along with its competitors, engaged in anticompetitive and unfair rebating practices. These practices are said to have artificially inflated the list prices of insulin drugs, limited patient access to more affordable options, and placed the burden of high insulin costs on vulnerable patients. Caremark also sits at the intersection of CVS’ retail pharmacy operation and its Aetna insurer, boosting the competitive advantage of both businesses. In the event of a breakup, it’s not clear where Caremark would fall. Separating Caremark from Aetna would put the insurance business at a competitive disadvantage since all its largest rivals have their own PBMs.
Post separation, management expects the retail stores to likely provide a stability to CVS on the back of its extensive physical network, holding over 60% of the US retail clinic market. In 3Q24, CVS’s retail clinics outperformed other business segments, benefiting from competitors’ retreats, such as Walmart’s exit due to a lack of profitability and Walgreens’ shift to specialty pharmacy expansion.
During its 3Q24 earnings call, CEO Karen Lynch mentioned that the company has developed a multiyear plan to generate as much as $2.0 billion in savings by continuing to rationalize its business portfolio. A recent filing stated that the company also plans to reduce its workforce by nearly 2,900 employees.
While a break-up looks promising, it is not necessarily the best course of action, as CVS’s business model moat is vertical integration. If the company breaks, it is likely to end up losing customers and revenues. What is more critical is that the management must devise a plan to improve the efficiency at Atena.
Company Description
CVS Health Corporation (Parent)
CVS Health Corporation, incorporated in 1963, is headquartered in Woonsocket, Rhode Island, US. CVS is a leading healthcare company that provides a wide range of health services and products. CVS operates through three segments: Health Care Benefits, Health Services, and Pharmacy & Consumer Wellness. Health Care Benefits offers health insurance products and services through Aetna. Health Services provides pharmacy benefit management, specialty pharmacy, and infusion services. Pharmacy & Consumer Wellness includes retail pharmacy operations, over-the-counter drugs, health and beauty products, and MinuteClinic walk-in medical services. As of June 30, 2024, the company had more than 9,000 pharmacy retail locations, more than 1,000 walk-in medical clinics, 207 primary care medical clinics, and a leading pharmacy benefits manager with approximately 90 million plan members. As of December 31, 2023, CVS had more than 300,000 employees in the
US. Health Care Benefits (Aetna) (Spin-Off)
Aetna offers a comprehensive range of health insurance products and related services. These include traditional, voluntary, and consumer-directed health insurance plans covering medical, pharmacy, dental, and behavioural health needs. Customers include employer groups, individuals, college students, parttime and hourly workers, healthcare providers, governmental units, government-sponsored plans, labour groups, and expatriates. As of June 30, 2024, medical membership stands at 27.0 million.