Tuesday, October 12, 2010

CVS Caremark: More Happy Talk, But Hard Work Remains

CVS Caremark (NYSE:CVS) held its 2010 Analyst Day last Friday. The happy talk is nicely encapsulated by the headline of The Wall Street Journal’s coverage: CVS Caremark Says Drug-Benefit Business Strong.

My $0.02: CVS Caremark’s management told a good story, but the underlying message remains the same: Keep waiting because the pot of gold is (still) just around the corner.

Friday’s meeting provided another list of intriguing ideas for how a mega-pharmacy chain and a top Pharmacy Benefit Managers (PBM) can live together without driving each other crazy. Many of these programs—Pharmacy Advisor, Maintenance Choice, Genetic Benefit Management, etc.—sound quite intriguing in theory but are not likely to translate into an insurmountable competitive advantage. Thus, I still expect CVS to spin off Caremark (per When will CVS and Caremark split up?), but probably not until 2012.

The Analyst Day slide deck is 170 pages and the transcript runs to 58 single-spaced pages, so I just focus on a few key points about the PBM business below. As always, Pembroke Consulting and Gerson Lehrman Group clients can schedule phone calls with me for additional insights beyond what I discuss in this post.

STUFF TO READ

You can download the entire 170 slide presentation from CVS’ 2010 Analyst Day web page. You can listen to the event for free, but you'll have to buy the transcript from earnings.com. I encourage you to review these materials for yourself because they are filled with useful competitive and market intelligence.

You may also be interested in a few of my recent posts on CVS Caremark:
THERE MUST BE A PONY IN HERE SOMEWHERE

The sheer scale of both CVS and Caremark obviously makes the combined company into a formidable presence in the U.S. healthcare system. But as of November 1, it will be four years since the CVS-Caremark merger was announced with a barrage of fluffy, happy talk about “significant benefits for employers and health plans through more effective cost management and innovative new program” (per the 2006 press release).

We’ve seen limited evidence of “significant” strategic benefits from the combination despite the positive uplift for CVS’ retail pharmacy. Maintenance Choice is a unique offering, but doesn’t seem to be creating a stampede to Caremark’s door. The forecasts from Friday imply no major market share gains for Caremark. There is also increased prospect of trouble for Caremark as a long-overdue systems integration begins. See below.

But read between the lines and another message came through: Caremark is now clearly focused on competing as a top PBM, not just as a nice-to-have adjunct to a large retail chain.

I credit Per Lofberg for this more aggressive and strategic posture. As I see it, Mr. Lofberg had two key qualifications to take over as the head of Caremark:
  1. He knows the PBM business better than almost anyone in the marketplace.
  2. He doesn’t need the money.
The second point is crucial because he has never had to worry about rationalizing a weak strategic fit. Here’s a telling comment by Mr. Lofberg from an earnings conference call only 5 weeks after he started his job:
“I think customers are first and foremost interested in how can they save money on their benefits programs, how can they get good service for their members. And they don’t really care that much if we are also a retail pharmacy chain in addition to being a PBM." (emphasis added)
Gotta give the guy credit for having the guts to say what he really thought, not what his boss wanted to hear.

CAREMARK’S PATH

Putting aside the synergy question, the PBM business doesn’t appear to be fundamentally broken, although there is a lot of work ahead to improve the business (or perhaps get it ready for a spin-off.)

Here are a few interesting nuggets that caught my eye.

Pressure on Generic Profits. The chart below spooked some people because it shows revenue growth of 11-13% but operating profit growth of only 9-11%.

When asked about the difference, Mr. Lofberg highlighted “more sophisticated” payers asking to “participate” in the savings from generic drugs. Put another way, pressure on generic profits is rising as payers learn more about channel economics, implement new payment benchmarks, and use novel contracting strategies. This is the countervailing force against super-sized profits from the coming generic wave—by now, a familiar topics for Drug Channels readers. (PBM restructuring expenses will also contribute to the revenue/profit disparity.)

Roll-up Indigestion. Caremark is really a roll-up of five PBMs—Caremark Rx, AdvancePCS, PCS Health Systems, Pharmacare (legacy CVS), and RxAmerica (legacy Long’s). The company plans to spend $450 million (in operating expenses and capital expenditures) to consolidate these platforms.

Alas, these projects often fall prey to Hofstadter’s Law of Information Technology:
"A system consolidation always takes longer than you expect, even when you take into account Hofstadter’s Law."
Stay tuned.

No international expansion. Mr. Lofberg pooh-poohed the idea of international expansion “given all of the challenges we have to work on here domestically.” The world is your oyster, Medco.

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All in all, a lot to ponder from this meeting. So, what did you think?

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