CVS to Buy All of Target’s Pharmacy Stores — A Win-Win For Both

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Not long after CVS Health (NYSE:CVS) acquired Omnicare (a pharmacy services provider) to strengthen its position in the PBM and specialty pharmacy markets, it bought all of Target’s (NYSE:TGT) more than 1600 pharmacy stores and 80 medical clinics. This makes CVS’ network of pharmacies the largest among its competitors. Not only does this move increase the company’s share of the total prescriptions filled in the US, but it will also yield additional benefits in the form of lower drug acquisition costs, leading to better EBITDA margins.

CVS Target

Expanding scale through acquisitions has been a common feature in the strategies being followed by major drugstore chains in the US. However, CVS’ model is different from any of its competitors because of the scale it has reached in both retail pharmacy and PBM spaces. Below, we will take a look at how both Target and CVS Health benefit from the deal.

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What’s In It for Target?

CVS Health agreed to pay a total of $1.9 billion for acquiring Target’s pharmacies and clinics. It is important to note that the pharmacies will remain a part of the existing Target stores, but will be operated by CVS. While such an agreement between competitors is unusual, the reasons are clear as it is a win-win deal for both parties.

Target has not been able to be as profitable in the pharmacy business compared to other segments it operates in. This can be attributed to the lack of a sizeable scale, which other players in this segment possess. As costs continue to increase, Target would have found it increasingly difficult to make any profits from this business. By letting the pharmacy business go, Target will be able to focus on its core strengths, while also benefiting from the customers that CVS will draw to its stores.

What’s In It for CVS?

On the other hand, CVS will benefit from a larger network of stores and more prescription sales. At the end of 2014, with more than 7,800 stores, CVS was only behind Walgreens (NASDAQ:WBA) as the largest pharmacy chain in the US. With this deal, it will have almost 9,500 stores and more medical clinics than before. A higher share of the total prescriptions filled in the US will place CVS on a stronger footing when negotiating prices with drug manufacturers and will likely lead to lower drug acquisition costs. Given the margin pressures seen in the industry (discussed below), lower costs will be the much needed respite for CVS Health.

Cost Squeeze From the Government is Driving This Change

Health care expenditures in the United States are currently about 18 percent of GDP, and this share is projected to rise sharply [1]. The Affordable Health Care Act, commonly known as Obamacare, is aimed at addressing this issue. The government will now be more involved in pricing of pharmaceutical products, which will motivate drug store operators to evaluate costs and steer patients to generic medications.

The cost squeeze is already starting to affect pharmacy retailers’ margins, such as the step down in Medicare Part D rates earlier this year. This continues to be one of the primary reasons, not only for CVS, but for leading companies across the healthcare sector to aim for a larger scale of operation.

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Notes:
  1. The Economic Case for Health Care Reform, The White House []