CVS Caremark must change pitch to save merger

By Jessica Wohl - Analysis

CHICAGO (Reuters) - When Tom Ryan orchestrated the $27 billion marriage of CVS and Caremark in 2007, he may not have imagined his sharpest critics would come back to haunt him more than two years later.

Ryan, the chief executive of the combined CVS Caremark Corp (CVS.N), stunned investors on Thursday by telling them the Caremark side of the company had lost $4.8 billion in business heading into next year.

For investors, the announcement undermined the very rationale of combining CVS's retail drugstore operations with Caremark's pharmacy benefits management (PBM) business, and company shares fell more than 20 percent. Some analysts invoked other failed megamergers, including the tie-up between AOL and Time Warner in 2001.

"While it is certainly possible that the company could turn things around ... we believe the best course of action may be for the company to unwind the merger of CVS and Caremark," William Blair analyst Mark Miller said in a note entitled "Dead Money Until Merger Is Unwound."

To add to shareholder concerns, CVS Caremark disclosed that the Federal Trade Commission is investigating some business practices of the combined company.

Now CVS, long a defensive stock play, has become a turnaround story nearly overnight. The length of that turnaround will depend on how quickly it can overhaul its pharmacy benefits management business, which administers prescription drug benefits for employers and health plans and operates a large mail-order pharmacy.

Until then, Ryan faces a tough sell to Wall Street.

"How do we look at the revised PBM outlook as anything but proof that no real clear synergy does exist here?" Bank of America/Merrill Lynch analyst Robert Willoughby asked Ryan during a conference call on Thursday.

"Well, we had $9 billion of new business in '08, and we have new clients," Ryan answered. "I get the question -- but the issue is, you have to back out the big losses. And the losses really, really weren't related to the model."

FIXING THE PITCH

The March 2007 marriage of drugstore operator CVS and pharmacy benefits manager Caremark Rx Inc raised many eyebrows when announced. Express Scripts Inc (ESRX.O) even tried to win over Caremark investors with a higher offer and a straight pharmacy benefits approach, but was rebuffed.

"It's hard to say that it's a 100 percent failure," said Sarah Henry, retail analyst at MFC Global Investment Management. "I think on paper it still works, but the execution piece has to get ironed out."

CVS beefed up its existing PBM business when it bought Caremark and runs its namesake chain of more than 7,000 drugstores.

Company executives admit that they were too enthusiastic about touting the benefits of CVS's retail prowess when they should have put more emphasis on the PBM business in their sales pitches. As a result, they lost out to more traditional players such as Express Scripts and Medco Health Solutions Inc (MHS.N).

"The sales force was so happy with the new toys that they weren't talking about the very, very solid core that we had, and therefore our message as a PBM was getting lost," Chief Financial Officer Dave Rickard told Reuters.