CVS - CVS Health Corporation

[KCLarkin]

I agree that in the short-term (2-4 years) CVS is going to be pressured by arbs and then by integration headaches. But shouldn't this be offset by tax reform?

 

 

 

 

 

 

[no_free_lunch]

At current prices it appears the aetna deal is worth $204 vs AET price of $180.  12% seems fairly decent for merger arb.  Anyone looking at AET?

[frommi]

I agree that in the short-term (2-4 years) CVS is going to be pressured by arbs and then by integration headaches. But shouldn't this be offset by tax reform?

 

I factored a lower taxrate into my numbers and the expected synergies. I should still give a reasonable return (8-12%) from here, i am just not willing to endure the short term pain for that return. And maybe they can pull a rabbit out of their hat and get much more out of the vertical integration than they are expecting themselfs. But the leverage is frightening when we get to a recession in the next 2-3 years.

[Guest notorious546]

I agree that in the short-term (2-4 years) CVS is going to be pressured by arbs and then by integration headaches. But shouldn't this be offset by tax reform?

 

I factored a lower taxrate into my numbers and the expected synergies. I should still give a reasonable return (8-12%) from here, i am just not willing to endure the short term pain for that return. And maybe they can pull a rabbit out of their hat and get much more out of the vertical integration than they are expecting themselfs. But the leverage is frightening when we get to a recession in the next 2-3 years.

 

 

How has this performed in past recessions?

[KCLarkin]

How has this performed in past recessions?

 

All of the businesses are recession-resistant. CVS grew revenue and earnings during the GFC. CVS will ladder debt maturities and FCF is very strong, so I don't think 4.6x is risky.

 

The scenarios where 4.6x becomes risky are mostly regulatory or competitive.

[frommi]

You are right, leverage is not a real problem when they work hard on deleveraging and at the next debt refinancing round interest rates are not a lot higher. So a recession can be a good thing for them when interest rates go down. What i don‘t get is that the arb spread is still so wide, are the regulatory hurdles so high?

[KCLarkin]

Looks like CVS got a stay-of-execution from the Amazon threat:

https://www.bloomberg.com/news/articles/2017-12-18/amazon-hasn-t-figured-out-drug-stores-yet-but-it-will-have-to

 

Unfortunately, the Aetna deal adds new uncertainty to the industry and will likely hold down both CVS and WBA for the foreseeable future.

[DooDiligence]

Looks like CVS got a stay-of-execution from the Amazon threat:

https://www.bloomberg.com/news/articles/2017-12-18/amazon-hasn-t-figured-out-drug-stores-yet-but-it-will-have-to

 

Unfortunately, the Aetna deal adds new uncertainty to the industry and will likely hold down both CVS and WBA for the foreseeable future.

 

“Amazon is in the business of saying yes, and pharmacy-benefit managers are in the business of saying no,” says George Hill, an analyst at RBC Capital Markets."

 

* An important distinction which they could circumvent?

 

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"Amazon could partner with a pharmacy to deliver online prescriptions through its two-hour delivery service Prime Now, to gauge demand without fully committing. And more recently, executives have mulled using Amazon’s voice-activated Alexa platform to remind users when it’s time to take pills and order refills."

 

* Who would partner with them just so they could be destroyed over the next decade?

 

* Using Alexa could for sure improve adherence.

 

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"Drug sales, though, involve long-term contracts covering millions of people through pharmacy-benefit managers, insurers and employers, none of which lend themselves to the rapid-fire experimentation and changes that have been key to Amazon’s success with other goods. Consider the complications. When a doctor sends in a prescription, the pharmacy has to check with the patient’s insurer to see whether the drug is covered and how much the patient owes, which depends on how much a patient has already paid towards a deductible. Where the drug falls in that particular plan’s formula also affects the amount the patient has to pay. If the drug isn’t covered, the doctor needs to be contacted—by the pharmacy or the patient—to send in a new prescription."

 

* This will require some serious disruption in the supply chain, not just one link but the entire chain.

 

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"Analysts still see plenty of ways for Amazon to enter the prescription drug market. Amazon could use its buying power to snatch up cheap generic drugs directly from manufacturers and sell them for cash to the uninsured, according to SSR Health. This is one place for Amazon to bypass the insurance companies and prescription benefit managers that make selling to insured patients so complex. One of the boldest ideas floated by several analysts would be for Amazon to buy a pharmacy benefits manager like Express Scripts Holdings Co."

 

* Selling to the uninsured is a great idea (there'll probably be a ton more uninsured soon) but I gotta wonder how many people in this income class actually use Amazon to begin with.

 

* As to Amazon buying Express Scripts (I'll stand in the back yard & scream for a full 5 minutes if this happens.)

 

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"If insured drug-takers become more cost-conscious, Amazon could attempt to bring convenient online price transparency to a complex industry that makes it difficult for customers to shop around. Amazon could be encouraged to push through the complexities to increase the value of Prime membership. Two-thirds of Prime members would fill prescriptions through Amazon if the company offered them, according to research by Cowen Inc."

 

* GoodRX

 

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* The threat to incumbents is real but vending pharmaceuticals is not the same as selling socks...

[DooDiligence]

CVS goes with the Hustler model of using untouched photos to market feminine beauty.

 

https://cvshealth.com/newsroom/press-releases/cvs-pharmacy-makes-commitment-create-new-standards-post-production

[DooDiligence]

CVS seems a lot better positioned than Express Scripts to accomplish savings for clients / payers.

 

https://payorsolutions.cvshealth.com/programs-and-services/transform-care/transform-rheumatoid-arthritis-care

 

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Opposing views?

 

I could smack myself for selling ESRX too soon.

 

It's officially the 1st stock I've ever sold at a loss out of fear.

[Cigarbutt]

"CVS seems a lot better positioned than Express Scripts to accomplish savings for clients / payers."

Cannot help specifically with that assessment but here are some tools.

 

The "optimization" of clinical care for rheumatoid arthritis has had parallel developments in the medical world and from the "cost management" industry which has been re-defining.

Typical examples (2010 and 2012):

http://www.amcp.org/data/jmcp/593-604.pdf

http://www.ajpb.com/journals/ajpb/2012/ajpb_2012_nov/impact-of-specialty-pharmacy-on-treatment-costs-for-rheumatoid-arthritis

My understanding is that the second link was "sponsored" by Express Scripts.

 

One of the fundamental problems is that incentives are not optimally aligned for the different players: patient, pharmacy, PBM entity, pharma manufacturer, insurer and the prescriber. For example, stand-alone PBMs have incentives to raise price in order to "capture" larger rebates. Also, categories of patients may benefit from relatively new "disease-modifying" agents which are more expensive. Indiscriminate cost containment may prevent those patients from access to more costly medications that may reduce complications and follow-up visits (good for insurer, especially if profit motivated) and may decrease long term disability and improve capacity to work and quality of life (good for the non-profit organization like Kaiser or the government who may be the ultimate payer somehow).

 

At this point, for rheumatoid arthritis, as well as for many other diseases, a very significant portion of patients do not get the effective care they need or get inappropriate (and often costly) treatments.

https://www.volksgezondheidenzorg.info/sites/default/files/bombardier_2012.pdf

 

Interestingly, a lot of useful data is available and the future seems to lie in the organization of this data into guidelines and algorithms.

http://www.ajmc.com/journals/supplement/2014/ace017_may14_ra-ce/ace017_may14_ra-ce_owens_s145tos152?p=1

 

FWIW, I don't see a long term viable moat for stand-alone PBMs. Integration of the PBMs into the insurer would go along way in terms of incentive alignment. Traditionally, stand-alone PBMs have described a dual role: cost containment and strategies to improve management. This dual mandate makes more sense when the payer is part of the equation.

https://client-prod.optumrx.com/vgnlive/CLP/Assets/PDF/RADTMWhitePaperFINAL.pdf

 

Simple telephone follow-ups by a nurse (or soon an alexa-type personal assistant) to the patient to optimize appointments, patient education, timely referral to rheumatologist and compliance. My opinion is that the profitable disruptive edge lies in the optimization and coordination of care.

 

FWIW, I don't see a convincing advantage in the combination of pharmacies and insurers.

 

 

[DooDiligence]

"CVS seems a lot better positioned than Express Scripts to accomplish savings for clients / payers."

Cannot help specifically with that assessment but here are some tools.

 

The "optimization" of clinical care for rheumatoid arthritis has had parallel developments in the medical world and from the "cost management" industry which has been re-defining.

Typical examples (2010 and 2012):

http://www.amcp.org/data/jmcp/593-604.pdf

http://www.ajpb.com/journals/ajpb/2012/ajpb_2012_nov/impact-of-specialty-pharmacy-on-treatment-costs-for-rheumatoid-arthritis

My understanding is that the second link was "sponsored" by Express Scripts.

 

One of the fundamental problems is that incentives are not optimally aligned for the different players: patient, pharmacy, PBM entity, pharma manufacturer, insurer and the prescriber. For example, stand-alone PBMs have incentives to raise price in order to "capture" larger rebates. Also, categories of patients may benefit from relatively new "disease-modifying" agents which are more expensive. Indiscriminate cost containment may prevent those patients from access to more costly medications that may reduce complications and follow-up visits (good for insurer, especially if profit motivated) and may decrease long term disability and improve capacity to work and quality of life (good for the non-profit organization like Kaiser or the government who may be the ultimate payer somehow).

 

At this point, for rheumatoid arthritis, as well as for many other diseases, a very significant portion of patients do not get the effective care they need or get inappropriate (and often costly) treatments.

https://www.volksgezondheidenzorg.info/sites/default/files/bombardier_2012.pdf

 

Interestingly, a lot of useful data is available and the future seems to lie in the organization of this data into guidelines and algorithms.

http://www.ajmc.com/journals/supplement/2014/ace017_may14_ra-ce/ace017_may14_ra-ce_owens_s145tos152?p=1

 

FWIW, I don't see a long term viable moat for stand-alone PBMs. Integration of the PBMs into the insurer would go along way in terms of incentive alignment. Traditionally, stand-alone PBMs have described a dual role: cost containment and strategies to improve management. This dual mandate makes more sense when the payer is part of the equation.

https://client-prod.optumrx.com/vgnlive/CLP/Assets/PDF/RADTMWhitePaperFINAL.pdf

 

Simple telephone follow-ups by a nurse (or soon an alexa-type personal assistant) to the patient to optimize appointments, patient education, timely referral to rheumatologist and compliance. My opinion is that the profitable disruptive edge lies in the optimization and coordination of care.

 

FWIW, I don't see a convincing advantage in the combination of pharmacies and insurers.

 

I'm in agreement with everything you said except the last bit.

 

I believe retail pharmacies (and patients) can both benefit from improved adherence & lower costs.

Vertical integration seems like it would give more access to tools & data (less protectionism) at POS & in homes; which should lead to better outcomes.

There needs to be some push & pull with regards to prices & efficacy, which in my mind, will lead to a kind of democratization.

 

I'm not sure if I'm just trying to justify being long CVS here or if I'm really being intellectually honest.

 

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Either way, Express Scripts does seem like a zombie unless they get owned by someone important (which I don't see until they're a lot more affordable.)

 

That said, my previous employer just re-signed with Express Scripts (I'm on COBRA) but I don't believe they have the expertise or willingness to really evaluate the landscape of alternatives.

[Cigarbutt]

"Vertical integration seems like it would give more access to tools & data (less protectionism) at POS & in homes; which should lead to better outcomes.

There needs to be some push & pull with regards to prices & efficacy, which in my mind, will lead to a kind of democratization."

Points well taken.

 

But,

 

-concerning the recent merger and "synergies".

I understand that when soda syrup makers looked into spinning off the bottlers, financial intermediary reports suggested there was value.

And when the syrup makers looked into bringing the subs/ventures back in house, financial intermediary reports suggested there was value.

I suggest that there was displacement of value with a commission.

If you like CVS and if you like Aetna, you can like CVS-Aetna but I submit that 1+1=2 minus friction costs.

 

-concerning integration at this stage of the game.

The merger is a form of backward integration. It occurs at a time when perhaps $ (and management attention) should be injected in R+D in order to offer a superior product and maybe as a "response" to potential threats coming from a completely different direction.

Quote from an old report (Robert H. Hayes and William J. Abernathy, “Managing Our Way to Economic Decline,” HBR July–August 1980) trying to delineate when vertical integration made sense:

"Sometimes the problem for managers is not their reluctance to take action and make investments but that, when they do so, their action has the unintended result of reinforcing the status quo. In deciding to integrate backward because of apparent short-term rewards, managers often restrict their ability to strike out in innovative directions in the future."

 

I respect your opinion but I think that the recent merger has more to do with the potential mirage of short term financial gains at the expense of long term competitiveness.

 

 

[DooDiligence]

"Vertical integration seems like it would give more access to tools & data (less protectionism) at POS & in homes; which should lead to better outcomes.

There needs to be some push & pull with regards to prices & efficacy, which in my mind, will lead to a kind of democratization."

Points well taken.

 

But,

 

-concerning the recent merger and "synergies".

I understand that when soda syrup makers looked into spinning off the bottlers, financial intermediary reports suggested there was value.

And when the syrup makers looked into bringing the subs/ventures back in house, financial intermediary reports suggested there was value.

I suggest that there was displacement of value with a commission.

If you like CVS and if you like Aetna, you can like CVS-Aetna but I submit that 1+1=2 minus friction costs.

 

-concerning integration at this stage of the game.

The merger is a form of backward integration. It occurs at a time when perhaps $ (and management attention) should be injected in R+D in order to offer a superior product and maybe as a "response" to potential threats coming from a completely different direction.

Quote from an old report (Robert H. Hayes and William J. Abernathy, “Managing Our Way to Economic Decline,” HBR July–August 1980) trying to delineate when vertical integration made sense:

"Sometimes the problem for managers is not their reluctance to take action and make investments but that, when they do so, their action has the unintended result of reinforcing the status quo. In deciding to integrate backward because of apparent short-term rewards, managers often restrict their ability to strike out in innovative directions in the future."

 

I respect your opinion but I think that the recent merger has more to do with the potential mirage of short term financial gains at the expense of long term competitiveness.

 

I've read a lot of your stuff & am grateful for your thoughts & the facts / links you dig up & share (here & elsewhere.)

 

Analysts should start issuing Fingers Crossed ratings.

[KCLarkin]

Cigna buying ESRX should make the CVS-AET integration less risky. One of the concerns with the merger is that insurers might want to use an independent PBM, rather than work with a competitor. With all of the top PBMs now aligned with an insurer, this is no longer a threat. And CVS continues to be uniquely positioned since they also own a retail pharmacy. Feeling better about the merger now.

[DooDiligence]

Not sure whether this belongs in the Davita thread or here.

 

https://www.cnbc.com/2018/04/04/cvs-health-eyes-kidney-patients-for-next-expansion-into-care.html

[DooDiligence]

https://www.cnbc.com/2018/04/13/cvs-minuteclinics-hires-marc-david-munk-as-chief-medical-officer.html

[Cigarbutt]

https://www.cnbc.com/2018/04/13/cvs-minuteclinics-hires-marc-david-munk-as-chief-medical-officer.html

 

Interesting nomination.

Mr. Munk is an advocate of innovation.

His focus is on primary care (first line) reform, value-based care and patient-centered outcomes.

I understand that he has worked on algorithms to facilitate timely referral to specialized resources.

 

But what is value in healthcare?

http://www.nejm.org/doi/full/10.1056/NEJMp1011024

 

One of the issues is precision versus accuracy. The "system" now is quite good in terms of the precision of many processes but relatively poor at the accuracy of outcomes. A lot of work to be done.

 

What does it mean for CVS?

 

IMO, despite the above nomination, they may have to deal with legacy thinking embedded in large institutions that benefit from the status quo.

 

https://www.hhs.gov/sites/default/files/fy-2017-hhs-agency-financial-report.pdf

Do not read unless you have an unusual interest.

The key parts describe "improper payments" for various programs (numbers are huge).

The report is a typical example of how large organizations can describe problems without realizing that they are part of THE problem.

May need your margin is my opportunity type of thinking.

The entrants will come from the outside.

 

[DooDiligence]

https://www.cnbc.com/2018/04/13/cvs-minuteclinics-hires-marc-david-munk-as-chief-medical-officer.html

 

Interesting nomination.

Mr. Munk is an advocate of innovation.

His focus is on primary care (first line) reform, value-based care and patient-centered outcomes.

I understand that he has worked on algorithms to facilitate timely referral to specialized resources.

 

But what is value in healthcare?

http://www.nejm.org/doi/full/10.1056/NEJMp1011024

 

One of the issues is precision versus accuracy. The "system" now is quite good in terms of the precision of many processes but relatively poor at the accuracy of outcomes. A lot of work to be done.

 

What does it mean for CVS?

 

IMO, despite the above nomination, they may have to deal with legacy thinking embedded in large institutions that benefit from the status quo.

 

https://www.hhs.gov/sites/default/files/fy-2017-hhs-agency-financial-report.pdf

Do not read unless you have an unusual interest.

The key parts describe "improper payments" for various programs (numbers are huge).

The report is a typical example of how large organizations can describe problems without realizing that they are part of THE problem.

May need your margin is my opportunity type of thinking.

The entrants will come from the outside.

 

Nice, I never knew that Porter wrote on the healthcare system.

 

It seems like payers and their partners (ESRX, etc.), and operators like CVS, who are nibbling around the edges of traditional healthcare delivery systems (hospitals, etc.), should be able to measure and act on these value based elements?

 

I don't know if I've chosen wisely with CVS but I feel fairly comfortable with the story I've created in my head.

 

Thanks.

[Cigarbutt]

CVS and the MinuteClinic story is compelling in a lot of ways.

 

The industry is ripe for change and change is likely to be rapid once a still undefined threshold has been reached but it may take a while and those with deep pockets may benefit when the plot thickens.

 

The "consumers" have had to (and will) pay more directly out of pocket and, for the part that is "shoppable", clinics that are run by retailers may have a relative edge.

 

[Txvestor]

I can assure you minute clinic is no competitive edge for CVS.

CVS/Aetna or Walmart/Humana are 3rd rate competitors to UNH and its well oiled operations up and down the health care spectrum. It's not even close.

Its a situation where I beleive the valuation gap does not adequately address the qualitative gap.

[Spekulatius]

CVS and the MinuteClinic story is compelling in a lot of ways.

 

The industry is ripe for change and change is likely to be rapid once a still undefined threshold has been reached but it may take a while and those with deep pockets may benefit when the plot thickens.

 

The "consumers" have had to (and will) pay more directly out of pocket and, for the part that is "shoppable", clinics that are run by retailers may have a relative edge.

 

I believe change in healthcare will be much much slower than some assume. The complexity, thr obvious importance of quality, inertia and the government involvement will very likely make this a multi decade effort. I am not sure that even AMZN has enough patience for this, they are known for their willingness to experiment, but they also quickly discard experiments that aren’t working either.

[KCLarkin]

CVS reported very good earnings this morning. The retail script volume was particularly strong.

 

They released 2018 adjusted EPS guidance of 6.87-7.08. With this mornings price drop, it is now trading at less than 10x forward earnings. Aetna transaction makes things a bit murky, but a consumer staple trading at less than 10x seems like a good bet.

[wolverine890]

Tell me if I am thinking about this wrong...

 

I was looking over CVS's Bond issuance this morning and it looks like there move at the beginning of the year was perfect timing on refinancing the company. They issued $40B in debt at an average rate of 4.1% (it was oversubscribed). Currently they have a little under $15B of callable debt trading below par. If the deal doesn't go through they could buy back their callable debt, which trades at an average discount to par between 8-2% reaping a meaningful profit? Additionally, they would reduce the leverage/risk of the current company and cover future debt issuance at low rates for years to come.

 

[KCLarkin]

CVS reported very good earnings this morning. The retail script volume was particularly strong.

 

They released 2018 adjusted EPS guidance of 6.87-7.08. With this mornings price drop, it is now trading at less than 10x forward earnings. Aetna transaction makes things a bit murky, but a consumer staple trading at less than 10x seems like a good bet.

 

The drop last weeks seems to be due to regulatory concerns. Specifically:

https://www.cnbc.com/2018/05/06/health-care-trump-set-to-unveil-drug-price-policy.html

 

I am highly sceptical of the Trump administration but Alex Azar seems highly competent. So this might actually turn into something. However, these are dynamic systems. If you legislate that rebates be passed to consumers (or make other policy changes), the system will likely adapt in ways that roughly preserve the current profit pools.

 

This is most obvious in Part D plans. If you pass the rebates on to the patients, then the plan sponsors will just raise premiums. This might be good policy, but won't materially impact profit pools.

 

The PBMs claim to already be passing on the rebates to plan sponsors, so they theoretically would see little impact. Though there is some debate about whether the PBMs are being honest about rebate pass-throughs.