CVS Health (CVS), the largest pharmacy health care provider in the U.S. with about 9,700 drugstores in 49 states, is probably among the most undervalued stocks around. But investors are wrong to ignore it.
On Dec. 3, 2017, CVS acquired -- with relatively little hoopla -- Aetna (AET), the nation's third-largest insurer and one of the most diversified health care benefits companies, for $77 billion. CVS' share price has dropped from its 52-week high of more than $84 a share to close at $77.77 on Monday
On Wall Street, shares of the acquirer in a merger deal usually get hit, while those of the target company climb. Usually. But the CVS purchase of Aetna can't be described as an ordinary merger. It combines the former's unmatched presence in local communities and its clinical capabilities with the latter's leading health care benefits and services.
The combined CVS-Aetna colossus promises to integrate health care services and better help consumers meet their health care needs, something that government programs and policies often struggle with. And the merger should generate significant returns for shareholders of both companies.
So some analysts who have looked at the deal more carefully have upgraded their recommendations on CVS, including those at Morgan Stanley (MS), which upgraded its rating on CVS to "overweight" from "equal-weight" with a price target of $90 share. Raymond James (RJF) has raised its rating on CVS to a "strong buy" from "outperform," also with a price target of $90 a share.
"We believe a combination, expected to close in the second half of 2018, makes strategic sense as it provides CVS with a greater ability to incentivize Aetna's 22 million health plan participants to utilize [CVS pharmacy benefit manager] Caremark's mail-order system or CVS retail stores," said Joseph Agnese, equity analyst at CFRA, who has a "hold" recommendation on both CVS and Aetna. He sees low- to mid-single-digit earnings-per-share accretion within two years of the deal's completion.
The transaction also eliminates the risk of CVS losing Aetna's business, which represents some 22 percent of CVS sales, noted Agnese. But to some Wall Street observers, CVS rushed to acquire Aetna to thwart any attempt by the voracious and acquisition-minded Amazon (AMZN) to acquire CVS. But no matter what motivated the deal, it provides CVS with new areas to increase sales and earnings growth.
"We believe the combination with CVS' pharmacy business management unit will increase the combined companies' leverage to better control costs," noted Agnese. Together, they'll have about $221 billion in sales and $18 billion in EBITDA (earnings before interest, taxes, depreciation and amortization).
CVS said in a public statement that the merged company fills an "unmet need in the current health care system and presents a unique opportunity to redefine access to high-quality care in lower-cost settings -- whether in the community, at home or through digital tools."
CVS CEO and President Larry J. Merlo said the acquisition "brings together the expertise of two great companies to remake the consumer health experience." He added that with Aetna's analytics and CVS' "human touch," they'll create a health care platform "built around individuals.
It's a natural evolution for both companies, he said, as "they seek to put the consumer at the center of health care delivery." CVS thus becomes, Merlo said, an even more integrated health care company, and Aetna moves beyond being a traditional insurer to focus more on "consumer well-being."
Aetna Chairman and CEO Mark T. Bertolini noted that increasing numbers of consumers are taking "more and more responsibility for paying for their health care as the burden of costs is being shifted to them." Together, CVS and Aetna will be a trusted community partner to help consumers better manage the cost of the health care they need, he said, "especially the 50 percent of Americans with chronic diseases that account for more than 80 percent of all health care costs."
CVS believes shareholders will benefit over the long term from the combined company's significant growth opportunities in new products and services as a "uniquely positioned integrated retailer, pharmacy benefits manager, and health plan."
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