Coverage: CVS buys Target pharmacy

CVS is looking to get even bigger. This time the company is trying to buy Target’s pharmacy business.

The New York Times story by Katie Thomas, Chad Bray and Hiroko Tabuchi had these details about the potential deal:

The voracious CVS Health is already a dominant player in nearly every corner of the health care world — it is the nation’s largest dispenser of prescription drugs, the biggest specialty pharmacy, the biggest operator of health care clinics and the second-largest pharmacy-benefits manager.

And with the news Monday that it had agreed to buy Target’s pharmacy and clinic businesses in a deal worth about $1.9 billion, it demonstrated that its appetite shows no signs of abating.

“CVS Health is building a business that has a lot of interlocking synergies in many different parts of the health care system,” said Adam J. Fein, president of Pembroke Consulting, a management advisory and business research company based in Philadelphia. “The Target deal is one more step in their goal of becoming the most significant company in the drug distribution and reimbursement system.”

Under the terms, CVS, which is based in Woonsocket, R.I., would acquire more than 1,600 pharmacies from Target in 47 states and operate them under the CVS brand name in Target stores. CVS will also operate branded pharmacies in new Target stores that offer pharmacy services.

CVS said it planned to rebrand about 80 clinic locations previously operated by Target under the MinuteClinic name, adding that they would be part of its plan to operate 1,500 clinics by 2017.

Charley Grant wrote for The Wall Street Journal that CVS is piling on the debt to make this and other deals happen:

The efficient use of capital doesn’t mean the acquisition is a free lunch, of course. The deal comes in the wake of CVS’s announcement last month of a $10.4 billion acquisition of Omnicare to bolster its benefit-management business.

CVS will be using debt to fund both deals. When adjusting for off-balance-sheet obligations like lease agreements, debt to earnings before interest, taxes, depreciation and amortization is expected to reach 3.2 times when both deals close. That is well above a year-end ratio of 2.4 times and the company’s leverage target of 2.7 times. Given this, CVS plans to trim its planned share repurchases by $1 billion this year, to $5 billion.

CVS expects the deal to be modestly dilutive to 2016 earnings per share, primarily due to the slowing buybacks. But with the stock near its record high, investing in a growth opportunity seems like a better use of capital. That should keep investors’ blood pressure in check.

Nathan Bomey wrote for USA Today that there were several compelling reasons for Target to sell its pharmacy business:

1. Complexity.The health care business is exceedingly complex, requiring a knowledgeable workforce to navigate a regulatory thicket that’s evolving rapidly in the wake of the Affordable Care Act.

Target’s primary business is selling consumer goods, not prescriptions. CEO Brian Cornell acknowledged Target simply lacks the expertise to operate its pharmacy business efficiently.

2. Profitability. Target’s pharmacy business was losing money. Chief Financial OfficerJohn Mulliganconfirmed the pharmacy business posted “modestly negative” results in the company’s last fiscal year, despite $4 billion in sales.
3. Lack of scale. Target is big, but its real estate footprint is not as wide as CVS’. Target had 1,793 U.S. stores as of 2013, while CVS had more than 7,800. In the pharmacy business, customers need quick access to medications, and more locations makes CVS a more enticing place to fill a prescription.

The Washington Post story by Sarah Halzack detailed how Target couldn’t make the business profitable:

CVS executives said the deal would allow them to reach a broader base of customers. They will enter metropolitan areas where they don’t currently have a strong presence, such as Seattle, Portland and Denver, and perhaps capture a different kind of shopper: While CVS’s 7,800 drugstores are often a destination for a “fill-in trip,” in which you grab two or three items, Target’s massive merchandise assortment makes it a logical destination for a bigger shopping trip.

“This partnership allows us to help those customers who may define convenience as a one-stop shop, or who may define convenience in a more episodic fashion,” said Larry Merlo, CVS’s chief executive, on a conference call with investors.

Target executives said Monday that while their pharmacy business drives traffic to their stores, its profitability last year was “modestly negative.” Chief executive Brian Cornell said that Target’s pharmacy business hasn’t boomed because of the retailer’s lack of scale and expertise in that area.

Cornell told investors Monday morning that pharmacy is “a very complex space in which we’re not positioned to be successful on our own.”

It’s smart to get out of a complicated business if you can’t manage it or hire to make it work. Selling the health care part to a proven entity could boost both brands and make customers happy. The price is high, but the deal looks like it will be a good one for both retailers.