NEW YORK (Reuters) - CVS Caremark, No. 2 U.S. drugstore chain, agreed to buy Universal American’s Medicare prescription drug business for about $1.25 billion to expand in a growing segment of the pharmacy benefit market.
The deal will more than double the size of CVS Caremark’s business that provides prescription drug coverage under the Medicare Part D program. Medicare is the U.S. government’s healthcare program for the elderly.
Universal American shareholders are expected to receive about $12.80 per share to $13.00 per share in cash for the business, which accounted for less than half of the company’s total revenue in the first nine months of 2010.
Universal American shares, which closed at $14.61 on Thursday, soared nearly 40 percent after the deal was announced on Friday. CVS shares stayed almost unchanged at $35.
CVS is acquiring the business for about 8 times operating earnings, a ”pretty reasonable“ price,” said Jeff Jonas, an analyst at Gabelli & Co.
The acquisition will make CVS a more formidable competitor to health insurers such as UnitedHealth Group Inc and Humana Inc, both major participants in the Medicare business. CVS expects the deal to add to its earnings in its first full year.
“It’s a good move for them (CVS),” said Kemp Dolliver, an analyst with Avondale Partners. “They become a larger competitor in Medicare Part D in a short period of time.”
The deal comes just as the first of the post war “Baby Boom” population becomes eligible for Medicare coverage.
Per Lofberg, president of Caremark Pharmacy Services, also cited the anticipated shift of retirees from employer-based coverage to Medicare under the new U.S. healthcare law.
Dolliver said the expanded healthcare coverage could also benefit CVS’s retail store operations.
“This is a population (those eligible for Medicare) that generates a lot of foot traffic, so you start moving them around into your stores from other people that makes a nice difference,” Dolliver said.
CVS’s move to expand its PBM operations comes as its chief rival, Walgreen Co, is seeking get out of the business. Walgreen, the No. 1 U.S. drugstore chain, hired Bank of America in October to sell its pharmacy benefits management unit.
CVS will buy all of Universal American’s shares outstanding and then distribute stock in a newly formed public company to Universal American shareholders. The newly formed company will own all other operations of Universal American, including its Medicare Advantage and traditional insurance businesses.
Universal American serves about 1.9 million Medicare prescription drug plan members, while CVS Caremark serves about 1.2 million Medicare drug plan members.
CVS has had a rocky history with its pharmacy benefits management business after buying Caremark for $27 billion in 2007. Caremark administers prescription drug benefits for employers and health plans and operates a large mail-order pharmacy operation.
Late in 2009, the PBM lost $4.8 billion in contracts heading into the new year, and the president of the unit departed. At the same time, CVS disclosed that the U.S. Federal Trade Commission was investigating some business practices of the combined company, leading many to question whether the merger made sense.
Since then, CVS has sought to fix the business, bringing in veteran Lofberg and changing the way it pitches to clients.
“Assuming you integrate it well and operate it well, I think it’s a good deal for them,” Jonas said. “But they’re still getting the PBM back on track and recovering from some missteps.”
The remaining business at Universal American will mostly be in Medicare Advantage, which are full-service health plans run by insurance companies under Medicare.
The U.S. government is scaling back payments to the Medicare Advantage plans, leaving some investors worried about companies that rely on them heavily.
“The Medicare Advantage business just gets such a low multiple in the market right now,” Jonas said.
CVS said the Universal American deal won’t affect its previously announced plans for dividends and share buybacks. It will shed more light on the deal when it gives its 2011 outlook on February 3.