CVS Sees Value in Pharmacy Benefits Business While Walgreens Is Selling

by Trefis Team
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Walgreens Co (NYSE:WAG) recently announced the sale of its prescriptions benefits management business, Walgreens Health Initiatives (WHI), to Catalyst Health Solutions for $525 million in cash, due to close in July 2011. [1] Given WHI’s insufficient scale to compete with the bigger players such as CVS Caremark (NYSE:CVS), it makes sense for Walgreens to focus on growing its already leading retail pharmacy network in the U.S. with over 7,600 drugstores spread across the nation. We wonder what’s making CVS stay put in the pharmacy benefit management services.

With over 1 billion prescriptions filled annually, CVS is the largest pharmacy services provider in the U.S., comprising of second largest network of over 7,025 retail pharmacies nationwide along with pharmacy services such as mail order pharmacy services, prescription plan design and administration and claims processing.  CVS acquired Caremark Rx, a leading pharmacy benefit manager, in March 2007 for $26.5 billion.

CVS Caremark plan members can now get their prescriptions filled at any of the more than 64,000 retail pharmacies, which helps CVS offer the U.S. consumers convenience like no other player. We estimate that Pharmacy Benefit Management makes up almost 19% of our $38 Trefis price estimate of CVS Caremark’s stock.

Outlook for Pharmacy Benefit Management (PBM) Business

1) Expansion of Healthcare

In Jan 2006, Medicare Part D came into effect and expanded coverage to millions of people who were previously uninsured. With the result, as of June 2010, over 29.3 million people were enrolled in Medicare Part D.

The Patient Protection and Affordable Care Act was signed into law on March 30, 2010 by President Obama and provides better insurance coverage for 32 million Americans that were uninsured or had preexisting conditions. An expansion of social programs like this will help increase consumption of prescription drugs, which could grow the addressable market for pharmacies.

2) Aging population and impending retirement of baby boomers

Baby Boomers (those born between 1945 and 64) are getting older and would need more medication in the years to come. Aging population of U.S., is expected to increase the per capita consumption of drugs.

3) Impact of rise in the number of partnering pharmacies

CVS’s pharmacy network currently boasts 64,000 partnering pharmacies (which includes 7025 CVS own retail pharmacy stores). Going forward, we expect the number of partnering pharmacies to increase as CVS expands its reach to more remote areas across the country. This has been a successful strategy that CVS could use for expansion.

4) Discounted pricing for mail order claims

CVS offers claims processing by delivering prescriptions over mail at much discounted prices compared to sales at the retail pharmacy stores. Although, CVS loses out on the front-door sales of cosmetics and other personal care goods by mail facility, it stands to make higher margins on account of lower costs incurred on servicing the consumer.

The Road Ahead…

Pharmacy Benefits Management is essentially a scale driven business. CVS acquired scale by the acquisition of Caremark. Catalyst Health Solutions is doing the same by acquiring Walgreens prescription benefits management unit, which shall increase the number of prescription benefits customers from its current 7 million to 18 million, more than doubling the number of prescriptions covered from 80 million to 165 million in the process.

Walgreens has chosen to disassociate from prescription benefits management to focus on its retail pharmacy business by infusing the cash raised from the sale into upgrading its drugstores and further expanding its retail footprint by opening more stores and/or acquiring independent pharmacies. Hence the leading two U.S. pharmacy players seem to pursuing different paths – Walgreens is focusing on a retail pharmacy network and CVS Caremark on a pharmacy services.

See a detailed analysis of our $38 Trefis price estimate of CVS Caremark and $43.30 Trefis price estimate of Walgreens.

Notes:
  1. Catalyst acquires Walgreens subsidiary, Gazette.net, March 11′ 2011 []
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