Caremark Dilutes CVS' Financial Appeal

Caremark, the pharmacy benefit management (PBM) firm that drugstore giant CVS bought for $21.2 billion in 2007, has proved to be a disappointment to its parent company. CVS chief executive Tom Ryan told analysts today that CVS won’t reach its profit goals in 2010 because of Caremark’s performance. As a result, CVS shares dropped 20 percent for their biggest one-day loss in eight years.

Caremark President Howard McLure will retire, and Ryan will temporarily run the unit himself. Ryan said Caremark’s profits might be 10 to 12 percent lower next year than in 2009. One reason is a loss of 500,000 members of Medicare Part D drug plans who are also eligible for Medicaid. That loss will cost Caremark $1.7 billion in 2010. The company has also lost contracts with New Jersey and Ohio, as well as Coventry Healthcare. Overall, Caremark is expected to lose $4.8 billion in contracts for next year.

It is reported that other companies outbid Caremark to win coverage of the “dual eligibles.” But some observers point out that there may also be a problem with CVS’ business model. While it bought Caremark to help steer more health plan members to its drugstores and sell them expensive drugs, the purpose of a PBM is to reduce the amount of prescription drugs-and particularly, brand-name medications-that plan members buy. So some plans and employers would rather go with a PBM that has no affiliations with a pharmacy chain.

Nevertheless, CVS turned in a robust third-quarter report. Its net revenues rose 18 percent to $24.6 billion. Volume in the pharmacy services segment (i.e., Caremark) jumped 23 percent to $13 billion, and in the retail pharmacy segment, sales jumped 18 percent to $13.6 billion. The company’s overall net income leaped a whopping 39 percent to $1.02 billion from $736 million for the prior-year period.

One analyst is urging investors to buy CVS stock. Tom Galluci of Lazard Capital Markets says that even with 2010 earnings projections down 7 to 8 percent, the company is very strong and is selling well below its true value. While Caremark is “underperforming,” Galluci argues, the stock is being valued at five times its estimated 2010 EBITDA, versus a ten times multiple for “pure-play” competitors that don’t include a PBM.

Well, perhaps, but the market does tend to base its valuations on earnings expectations. Unless some new development convinces investors that CVS’ business model is sound, they’re likely to punish its stock.