Tuesday, June 16, 2015

CVS Aims at Target: Deal Analysis and Marketplace Implications

Wow! I didn’t see this one coming.

Yesterday, CVS Health announced that it will acquire Target’s pharmacy business and operate the pharmacies as a CVS-branded, store-within-a-store format. Read the press release.

Below, I review key deal terms and what they mean for CVS and Target. I also consider derivative impacts on McKesson, Cardinal Health, Diplomat Pharmacy, and Catamaran. I’ll discuss Walgreens in an upcoming post.

This marks the first big pharmacy outsourcing arrangement by a mass merchant or supermarket. Will more deals follow?

THE NEWS

The story was widely covered yesterday. Here are two significant stories that outline the transaction’s high points:
If you don't like to read, you can listen to me discuss the deal on the Marketplace radio program and on National Public Radio.

THE DEAL

Here are the key deal terms:
  • CVS will take over the management of all Target pharmacies, which will be rebranded as CVS retail pharmacies. In April, Drug Store News estimated that Target had 1,669 stores with pharmacies and 126 stores without pharmacies.
  • Target’s nearly 80 retail clinic locations will be rebranded as CVS Health MinuteClinics.
  • CVS Health will open “up to 20 new clinics” in Target stores within three years of the close of the transaction.
  • The companies will partner on as many as 10 new smaller-format stores that will be branded as TargetExpress and include a CVS pharmacy.
Incredibly, the Target deal comes less than a month after CVS Health announced its acquisition of Omnicare. Here’s what I said in The New York Times article:
”CVS Health is building a business that has a lot of interlocking synergies in many different parts of the health care system. The Target deal is one more step in their goal of becoming the most significant company in the drug distribution and reimbursement system.”
CVS Health epitomizes the organized channel customer. Manufacturers should pay close attention to what's happening.

WHY IT MAKES SENSE

Highlights for CVS:
  • CVS will quickly add nearly 1,700 retail locations, which would otherwise have been a costly and time-consuming endeavor. Once the deal closes, CVS retail will operate an astonishing 9,600 retail stores, or about one out of seven retail community pharmacy locations.
  • CVS adds scale in at least four cities—Seattle, Denver, Portland, and Salt Lake City. The additional stores make CVS Caremark’s Maintenance Choice offering more attractive to plan sponsors. There is relatively limited store overlap, so the Target-based pharmacies should not significantly cannibalize any nearby CVS retail pharmacies.
  • The Red Oak joint venture with Cardinal Health also gains additional generic buying power. Sorry, generic drug makers!
  • CVS has many options for improving Target’s pharmacy profitability. Target disclosed that its pharmacy business lost money. Its pharmacy gross margin, however, is a reasonable 24% of revenues.
Highlights for Target:
  • Since Target lacks significant specialty pharmacy expertise, it would have had to build or buy better specialty capabilities. Target shoppers will instead get access to specialty drugs via CVS Health’s Specialty Connect Program. See my comments below on Target’s relationship with Diplomat Pharmacy.
  • Target avoids figuring out how to build scale for generic drug purchasing.
  • Target will get $20 million to $25 million in annual rent payments. Sweet.

OTHER PLAYERS

Here are some implications for other drug channel participants.

Cardinal Health and McKesson McKesson is Target’s primary wholesale supplier for brand-name drugs, while Target had primarily purchased generic drugs directly from the manufacturer. Target had been a high-profile, um, target for converting its generic purchases to McKesson’s OneStop program, a la the Rite Aid-McKesson arrangement. With the CVS deal, brand-name supply will likely switch to Cardinal Health, while generic sourcing will shift to Red Oak.

This is the second negative deal for McKesson, which will lose Omnicare’s brand and generic business after the CVS Health acquisition closes.

Diplomat Pharmacy Target is the biggest retail chain in Diplomat Pharmacy’s Retail Specialty Network (RSN) program, which provides outsourced specialty pharmacy services for a per-prescription fee. I expect that CVS Health’s Specialty Connect program will be rolled out to the pharmacies inside Target stores.

Catamaran and OptumRx In April 2013, Catamaran began a three-year contract as the PBM for Target’s employees. I assume that when the contract ends in April 2016, Target will shift its PBM business to Caremark. Since Catamaran is being acquired by UnitedHealth Group’s OptumRx PBM, the CVS-Target deal becomes a slight negative for OptumRx, too. I wonder if the deal will be repriced.

I'll have more to say about Walgreens later this week. In the meantime, check out the articles listed in the right sidebar under "Dr. Fein in the News."

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