On December 3rd, 2017 CVS Health Corporation announced its intention to acquire Aetna Inc. in a cash-stock deal for $69 billion, in what will be the largest corporate deal in 2017 so far. The Wall Street Journal reported that the two companies have been in talks since late October. CVS’ stock dropped more than 4.6% on December 4th when the transaction was publicly presented. The deal, set to be one of the largest healthcare mergers in the past decade, will combine the biggest US drugstore chain with the third-largest health insurer. The deal is expected to close in the second half of 2018.
If the deal goes through, the hefty price tag would easily surpass Express Scripts’ $29 billion acquisition of Medco in 2012, the current largest health provider merger. “I think the important thing for consumers to look out for going forward is how prices are likely to change,” said Amanda Starc, associate professor of strategy at Northwestern’s Kellogg School of Management. In other words, “your insurance company now cares not just what you’re spending on drugs but what you’re spending on overall medical utilization,” Starc said. Those combined services that CVS and Aetna could provide in pharmacies and clinics could make not only visits to the hospital but visits to a primary care physician’s office less necessary.
Industry overview
After 2015, a record-breaking year for the Healthcare industry both in terms of volume and value, M&A activity in 2016 declined quite sharply despite the significant number of mega deals over $10bn. The end of the so-called “domino effect”, which encouraged corporations to take part in more deals in the light of the success of their peers, together with several changes to the rules on tax inversion deals highlighted by Andrew Nicholson, KMPG’s Global Head of Healthcare, made less attractive for corporates to pursue M&A strategies.
Although 2017 complete reports and results have not been published yet, in the first 3 quarters M&A activity in the sector has remained in line with the trend of the previous years excluding 2015, which remains an exception. The expectation of costs shifting to a value-based approach, the need for companies to develop direct consumer-facing brands and strong financial pressures will consolidate “M&A” as the main response to changes in this dynamic and innovative industry. The main buyers driving Healthcare M&A activity are expected to be United States, United Kingdom and China, with the latter accounting mainly for smaller-value deals. In addition to these three big players, there is a growing trend also for Japan and Switzerland in seeking growth outside their home markets via M&A.
So far 2017 has still been a respectable year in terms of volume, even if the value of deals has declined mainly due to the announced tax changes highlighted above. In the last few years the pharmaceutical industry has been stressed by several challenges and, in particular, the major contributor to the realized volatility was the political framework and technology advancements that demand substantial R&D investments over time. The recent growth in the sector is closely tied to global health care expenditures which, in 2017 and successive years, are expected to be fueled by increasing demand from an aging population and by the prevalence of chronic and communicable diseases.
In response to these changes, firms are working primarily on cost cutting and, in a second instance, they are attempting to enlarge their portfolio of products to strengthen profit margins. On the other hand, fast-growing emerging markets are being targeted in order to expand the customer base and increase global market share. Nowadays, the industry’s ten largest companies have a combined market share of 46.7%, while other smaller and more specialized firms mainly operate in niche markets. Deal making has slowed since Donald Trump became US president, as several drug-makers have been waiting for more clarity on drug pricing and tax reform.
Companies overview
CVS
Founded in 1964, CVS Health is a US retail pharmacy and healthcare company headquartered in Woonsocket, Rhode Island. The company currently employs more than 240,000 people and generated sales of $153bn in 2016. As of today CVS has more than 9,700 pharmacy locations and more than 1,100 walk-in health care clinics across the United States, offering health screenings, vaccinations, lab tests and treatment for common illnesses or injuries.
CVS Pharmacy stores dispense more prescriptions than any other drugstore chain. In general the company provides a variety of different services including retail pharmacy, pharmacy benefits management, clinical services, specialty pharmacy and digital services. The company’s retail pharmacy stores sell prescription drugs and a wide assortment of general merchandise, including over-the-counter drugs, greeting cards, beauty products and cosmetics and other products. CVS also engages in Pharmacy Benefit Management providing a full range of prescription benefit management services to managed care institutions and other organizations. Overall the company serves to more than 75 million plan members. Key services include plan design and administration, mail order pharmacy services, formulary management and claims processing. The PBM business, manages approximately 15 million lives, operates under the PharmaCare Management Services name and ranks as one of the top ten full service PBMs in the nation.
Furthermore the company operates its own care clinics with nurse practitioners and physician assistants treating minor health conditions on demand. Key services include the performance of health screenings, monitoring chronic conditions and the delivery of vaccinations. The specialty pharmacy provides support for individuals that require complex and expensive drug therapies to treat conditions such as organ transplants, HIV/AIDS and other health issues such infertility, multiple sclerosis or certain cancers. Apart from that the company offers digital services mainly through its online application which should facilitate the acquisition of CVS Health Products for the end customer.
Aetna
Established in 1853, Aetna is one of the leading diversified health care benefits companies in the U.S., serving an estimated 45 million people regarding medical, pharmaceutical, dental, behavioural health, long-term care, and disability plans. Its global benefits include medical, dental, vision and emergency assistance and, in some regions, life and disability. Besides, the company offers customised technological and health management solutions for health care systems, government entities and large employers.
The company currently employs about 50,000 people and is headquartered in Hartford, Connecticut. It offers health and dental benefit products including health maintenance organization, point-of-service, preferred provider organization and other related products. Furthermore, it sells group insurance products such as life, disability and long-term care insurance solutions. In the field of large case pensions Aetna provides retirement products including pension and annuity products primarily addressed to defined benefit and defined contribution plans.
Deal Structure
Aetna shareholders will receive $207 per share owned – $145 in cash and 0.8378 of a CVS share, or, equivalently, $62 in stock. This represents a 29% premium above the price Aetna’s stock was trading on October 25th, the day after the press reported the two companies had started negotiations. This is consistent with the target’s current price, which is trading at more than 33 times its Trailing Net Income. Considering Aetna’s Net Financial Position (Financial Debt less Cash and Marketable Securities), the deal would be worth $77 billion. CVS Health is expected to finance the acquisition with $49 billion with newly issued Debt (provided by Bank of America Merrill Lynch, Barclays and Goldman Sachs), $22.1 billion with Equity and only through $4.1 billion in Cash.
This transaction will create, if it meets the regulatory requirements, a behemoth with approximately $240 billion in combined revenues; these will come from the exploitation of Aetna’s solid position in the health insurance sector with 22 million of customers and CVS’ 10,000 pharmacies across the US, which, overall, filled 2.4 billion prescriptions in 2016. This cash-stock transaction is expected to create nearly $750 million in annual cost synergies, improving CVS’ bargaining power over drug makers.
After the completion of the merger, Aetna’s shareholders will end up owning 22% of the combined entity, CVS Health shareholders roughly 78%. For what concerns the corporate governance ex-post, CVS’ CEO Larry Merlo will continue serving as chief executive of the merged entity, keeping Aetna as a stand-alone unit. Nevertheless, three of Aetna’s directors, among which Chairman and CEO Mark T. Bertolini, who will not have any operational role, will be present in the newly formed Board of Directors. Mr. Bertolini is expected to benefit as much as $0.5 billion if the deal will finally meet regulatory conditions.
Were the merger not to occur, CVS Health is bound to pay a termination fee of $2.1 billion, according to the merger agreement presented on Tuesday 5th. Earlier this year, Aetna paid $1 billion to Humana after regulators blocked the $37 billion takeover.
Deal Drivers
Since Amazon is reportedly considering entering the pharmacy industry, some analysts have interpreted the recent announcement of CVS Health to acquire America’s third largest provider of health insurance as a defence mechanism. Amazon, bringing its low-cost model to the pharma business through the online sale of prescription drugs, would naturally constitute a threat to America’s biggest pharmacy chain. With the acquisition of Aetna, CVS would both diversify its profit streams and create reasons for customers to physically visit their stores.
In particular, through the deal, the combined company hopes to disrupt the healthcare business. Larry Merlo, CVS Health’s CEO said that, by bringing different traces of the industry together, the deal would modify the consumer healthcare experience. The plan is for CVS to turn its stores into “healthcare hubs”, hire specialists and hence offer services and advise on top of their disposal of drugs.
Currently, in healthcare, billions of dollars are spent on chronic conditions. CVS predicts that it will be able to reduce customers’ usage of more expensive services such as hospitals, therefore leading to enormous cost savings for Aetna. CVS hopes to gain market share by passing on parts of these savings to Aetna’s clients. The is not only expected to help CVS compete against new market entrants such as Amazon, but also to compete with other integrated healthcare providers, such as UnitedHealthcare, that have reportedly already taken business away from CVS. Meanwhile, Aetna has failed to grow as quickly as its peers, too.
The main driver behind 2017’s biggest deal is to make it both cheaper and easier for customers to access care and medication. After horizontal M&A in the insurance industry has been blocked due to antitrust concerns, a vertical merger as in the case of CVS and Aetna could provide customers with a new kind of healthcare experience by combining different stages of the supply chain. The traditional care in the U.S. is very expensive and, at the same time, many functions that hospitals provide may become obsolete in the future. New market entrants, on the contrary, are able to modify processes and form a new business model with advanced technologies that is centred around the customer and avoids the bureaucracy and inefficiencies of traditional customers.
CVS’s CEO Larry Merlo confirmed that the ultimate goal of the deal would be “promoting lower-cost sites of care”, meaning converting brick and mortar stores into treatment centres that employ medical staff. The motivation is that this will not only create efficiencies but also prevent customers from visiting more expensive hospitals, lowering costs for insurers and hence, customers.
Advisors
Barclays and Goldman Sachs served as financial advisors to CVS, while Centerview Partners also provided financial advice to CVS’s board. Lazard Ltd and Allen & Company LLC were financial advisors to Aetna and Evercore served as independent financial advisor to Aetna’s board.
Sources and References: Bloomberg, Companies’ websites, Financial Times, Wall Street Journal, Seeking Alpha, Business Insider, Fortune
To contact the authors:
Federico Campanini federico.campanini@studbocconi.it
Luan Gölz luan.goelz@yahoo.de
Johanna Hof johanna.hof@whu.edu
Marta Naidenova marta.naidenova@gmail.com
Marco Monaco marco.monaco@studbocconi.it
Camilla Veroni camilla.veroni@gmail.com
To contact the editor responsible for this story:
Marta Naidenova marta.naidenova@gmail.com
Bocconi Students M&A Circle 
You must be logged in to post a comment.