CVS CEO Says Government Contract Win Will Hurt Retail PBM Margins
June 01 2011 - 3:30PM
Dow Jones News
CVS Caremark Corp. (CVS) recently won a lucrative government
contract now held by Medco Health Solutions Inc. (MHS), helping
fuel what CVS hopes is a turnaround for its pharmacy-benefits
management business, but its chief executive acknowledged the win
comes at a cost.
Larry Merlo, who took the helm of CVS earlier this year, on
Wednesday told a Sanford C. Bernstein conference that the
"transparent" pricing of the new pact to serve over 5 million
federal employees, retirees and dependents will lower the margins
at the retail pharmacy side of the PBM business. Merlo declined to
be more specific, citing company policy to not discuss the
profitability or financial details of any one contract.
CVS has held, since 1993, the contract to provide just the PBM
service at its retail CVS drugstores to the Federal Employee
Program, or FEP, administered by Blue Cross Blue Shield. With this
new deal, it will begin next year to integrate mail-order and
specialty pharmacy benefits management. Medco had previously
managed the FEP's mail-order pharmacy benefits, and its financial
chief earlier told the same conference that Medco had made a "very
competitive" offer for the combined future FEP business, adding the
government told Medco it chose CVS based on the financials of the
contract CVS proposed.
Medco CFO Richard Rubino noted that the company has lost FEP as
a customer before and won it back. "It's never over with FEP."
Merlo continued to press the case that the combination of the
retail pharmacy and PBM business, created with the 2007 merger of
CVS and Caremark, will finally begin to show tangible benefits next
year, following years of struggles to integrate the two businesses.
Caremark has struggled with internal missteps and against opponents
who accuse the combined company of unfair and anticompetitive
practices, and it lost a total of $4.8 billion in contracts last
year.
When CVS reported first-quarter results last month, Merlo put
forth his most ardent defense of the merger, rebuffing those who
have called for the two businesses to be separated and outlining a
multi-step plan to make Caremark a success. Under the leadership of
Per Lofberg, a respected PBM industry veteran CVS hired in late
2009 who was once Medco's chairman when it was part of Merck &
Co. (MRK), CVS has aggressively gone after revenue-generating
business. In addition to securing the FEP, Caremark also recently
garnered the PBM contract to service Aetna Inc. (AET) members, but
like with the FEP contract, the aggressive pricing will crimp
margins in the short term.
Between the third quarter and fourth quarter of this year will
show the "most dramatic" improvement of its PBM business, CVS CFO
David Denton said during the company's post-results conference
call.
At the conference, Merlo said the proof that Caremark has turned
the corner will be a dramatic increase to the company's cash flow.
He said it will generate upward of $30 billion in cash flow over
the next five years. Where the projected returns on invested
capital make sense, CVS will invest that cash flow in the business,
and it intends to return the rest to shareholders in the form of
dividends and share repurchases.
With the ratio of its dividend to its earnings that CVS is
targeting, the implied annual growth of the dividend is 25% or so,
Merlo said.
-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171;
maxwell.murphy@dowjones.com
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