Mergers and BDB

-Justin Barcusky

This past January, Warren Buffett, Jamie Dimon, and Jeff Bezos proposed a joint-effort solution to lowering the cost of healthcare (BDB proposal). Once again, Wall Street responded with a large sell-off in response to an “Amazon-Bezos” headline, as shares of CVS and Walgreens tumbled on the news and are still being downplayed. With this looming competition being led by some of the greatest business minds, current healthcare player CVS is taking extraordinary measures with a strategic merger to fend off the threat. The CVS-Aetna deal was actually announced last December prior to the BDB proposal. According to the Wall Street Journal, CVS CEO Larry Merlo says of the merger that “the combined company will be well-positioned to reshape the consumer health care experience, putting people at the center of health care delivery to ensure they have access to high-quality, more affordable care where they are, when they need it.” This merger puts CVS in a strong position to protect themselves against any type of Amazon-like threat. That is, CVS operates in retail stores, which Amazon has crushed. What data is starting to show, however, is that there are certain types of brick-and-mortar retailers that Amazon is having a tougher-than-expected time penetrating, and those include offprice stores, specialty designers (take away the fact the mall foot traffic is lower), and furniture and electronic stores. While CVS does not fall into any of these categories, there is an aspect of the business that can be prioritized to keep itself afloat: the fact that certain goods need to be made ready on demand. Amazon’s model is 2-day shipping. The reality is that no one is going to wait two days for medicine when all he/she needs is instant relief. Imagine putting off antibiotics for two days with a terrible sinus infection. It would be awful. With this in mind, CVS has a competitive advantage in this aspect. Medicine is ready for pick-up in well-positioned stores around the country within less than an hour, and the merger with Aetna can create cost synergies to lower prices for in-store pharma products, something that consumers are willing to go to brick-andmortars for if they can get a better deal. While Amazon is experimenting with 2-hour delivery with groceries, which could be a threat to this system if done with pharmaceuticals, the addition of Aetna at this moment can create high switching costs for Aetna subscribers. Those insured by Aetna are probably going to have CVS as a default pharmacy, which will make it hard for any new entrants to win over market share and current subscribers to leave the network.

As well, if the BDB proposal does provide exceptional service, CVS now has a method of delivery with Aetna Home Delivery. The current state of Aetna Home Delivery is that it provides up to a 90-day supply of medicine for customers that need constant refills. Once under CVS’s control, it will again make it hard for subscribers to break lose from this structure, mitigating some of the harm the BDB proposal could have on disrupting the industry.

What is most important about all of this is that both CVS and Aetna shareholders are happy with this move. In fact, 98+% of CVS shareholders and 97+% of Aetna shareholders voted in favor of this merger, which will be effective later in 2018 with Aetna shareholders receiving $145 in cash and 0.8378 shares of CVS per share of Aetna. It is clear with these numbers that there is a strong sense of approval and confidence in where this new company can go, which over time should continue to return strong value for investors. Overall, it is hard to anticipate what will happen in the future because time and time again the American economy proves to be so dynamic. With what is known now and can be reasonably anticipated, however, the CVS-Aetna merger appears to be a strengthening force for the companies’ portfolios. Within this threat from the BDB proposal is a good illustration of how competition is ultimately the driving force for higher quality goods and services at a lower cost for consumers. It will be important to follow this story closely moving into the future.