CVS is considering a break up. Here’s why that may very well be dangerous

It is time for a wellness check at CVS Health.

Shares of the corporate are down greater than 20% this yr because it grapples with higher-than-expected medical costs in its insurance unit and pharmacy reimbursement pressure, amongst other issues.

Because it seeks to claw back faith with Wall Street, the corporate is considering breaking itself up.

CVS has engaged advisors in a strategic review of its business, CNBC reported Monday. One option being weighed is splitting up its retail pharmacy and insurance units. It might be a shocking reversal for the corporate, which has spent tens of billions of dollars on acquisitions over the past 20 years to show itself right into a one-stop health destination for patients.

Some analysts contend that a breakup of CVS can be difficult and unlikely. 

CVS risks losing customers and revenue if it splits up its vertically integrated business segments, which incorporates health insurer Aetna and the foremost pharmacy advantages manager Caremark. That might translate to more lost profits for a health-care giant that has slashed its full-year 2024 earnings guidance for 3 consecutive quarters. 

“There really isn’t any perfect option for a split,” said eMarketer senior analyst Rajiv Leventhal, who believes a breakup remains to be a possibility. “If that does occur, one side of the split becomes really successful and prosperous, and the opposite would significantly struggle.”

Notably, CVS executives on Monday met with major shareholder Glenview Capital to debate fix the flailing business and get better its stock, CNBC previously reported. But Glenview on Tuesday denied rumors that it’s pushing to interrupt up the corporate.

If CVS stays intact, CEO Karen Lynch and the remaining of the management team could have to execute major changes to handle what industry experts say are glaring issues battering its bottom line and stock price.

The corporate has already undertaken a $2 billion cost-cutting plan, announced in August, to assist shore up profits. CVS on Monday said that plan involves shedding nearly 3,000 employees.

Some analysts said the healthcare giant must prioritize recovering the margins in its insurance business, which they imagine is the principal issue weighing on its stock price and financial guidance for the yr. That pressure drove a leadership change earlier this yr, with Lynch assuming direct oversight of the corporate’s insurance unit in August, displacing then-president Brian Kane.

CVS’ management team and board of directors “are continually exploring ways to create shareholder value,” an organization spokesperson told CNBC, declining to comment on the rumors of a breakup. 

“We remain focused on driving performance and delivering prime quality healthcare services and products enabled by our unmatched scale and integrated model,” the spokesperson said in an announcement. 

Investors may get more clarity on the trail forward for the corporate during its upcoming earnings call in November.

Some analysts said the likelihood of CVS separating its retail pharmacy and insurance segments is low given the synergies between the three combined businesses. Separating them could include risks, they added. 

“The strategy itself remains to be vertical integration,” Jefferies analyst Brian Tanquilut told CNBC. “The execution won’t have been the best, but I feel it’s a bit of too early to essentially conclude that it is a broken strategy.”

Lots of CVS’ clients contract with the corporate across its three business units, in keeping with Evercore ISI analyst Elizabeth Anderson. Anderson said “carving out and pulling apart a complete contract” within the event of a breakup could be “quite difficult operationally” and result in lost customers and revenue. 

Pharmacy advantages managers like CVS’ Caremark sit at the middle of the drug supply chain within the U.S., negotiating drug rebates with manufacturers on behalf of insurers, creating lists of preferred medications covered by health plans and reimbursing pharmacies for prescriptions. 

Meaning Caremark also sits on the intersection of CVS’ retail pharmacy operation and its Aetna insurer, boosting the competitive advantage of each of the companies. Within the event of a breakup, it is not clear where Caremark would fall.

Separating Caremark from Aetna would put the insurance business at a competitive drawback since all of its largest rivals, including UnitedHealth Group, Cigna and Humana, even have their very own PBMs, said eMarketer’s Leventhal. 

CVS is the highest U.S. pharmacy by way of prescription drug revenue, holding greater than 25% of the market share in 2023, in keeping with Statista data released in March. Walgreens trailed behind with nearly 15% of that share last yr. 

Now, CVS drugstores must maintain an edge over competitors at a time when the broader retail pharmacy industry faces profitability issues, largely resulting from falling reimbursement rates for prescribed drugs. Increased competition from Amazon and other retailers, inflation and softer consumer spending are making it tougher to show a profit on the front of the shop. Meanwhile, burnout amongst pharmacy staff can be putting pressure on the industry. 

CVS’ operating margin for its pharmacy and consumer wellness business was 4.6% last yr, up from 3.3% in 2022 but down from 8.5% in 2019 and 9.9% in 2015.

CVS and Walgreens have each pivoted from years of infinite retail drugstore store expansions to shuttering lots of of locations across the U.S. CVS is wrapping up a three-year plan to shut 900 of its stores, with 851 locations closed as of August.

The rocky outlook for retail pharmacies could make it difficult for CVS to search out a buyer for its drugstores within the event of a split, in keeping with Tanquilut. He said a by-product of CVS’ retail pharmacies can be more likely.

“There is a reason they’re cutting down stores. Why break it up when the connection between Caremark and CVS retail is what keeps it outperforming the remaining of the pharmacy peer group?” Tanquilut said. 

That features two recent acquisitions: fast-growing primary care clinic operator Oak Street Health, which the corporate acquired for $10.6 billion last yr, and Signify Health, an in-home healthcare company that CVS bought for about $8 billion in 2022. Those deals aimed to construct on CVS’ major push into healthcare – a method that Walgreens and other retailers have also pursued over the previous few years. 

Oak Street Health could theoretically be spun out with Aetna within the case of a split, Mizuho managing director Ann Hynes wrote in a research note Tuesday. 

The first care clinic operator complements Aetna’s Medicare business since it takes care of older adults, offering routine health screenings and diagnoses, amongst other services. CVS also sells Aetna health plans that provide discounts when patients use the corporate’s medical care providers. 

But CVS has also began to integrate Oak Street Health with its retail pharmacies. The corporate has opened those primary care clinics side-by-side with some drugstore locations in Texas and Illinois, with plans to introduce around two dozen more within the U.S. by the tip of the yr. 

Several firms, including Amazon, Walmart, CVS and Walgreens, are feeling the pain from bets on primary care. That is because constructing clinics requires a number of capital, and the locations typically lose money for several years before becoming profitable, in keeping with Tanquilut. 

Walgreens could potentially exit that market altogether. The corporate said in a securities filing in August it’s considering a sale of its primary care provider VillageMD.

But Tanquilut said it could not make sense for CVS to sell Oak Street Health or Signify Health because “they’re actually hitting their numbers.” 

Signify saw 27% year-over-year revenue growth within the second quarter, while Oak Street sales grew roughly 32% in comparison with the identical period last yr, reflecting strong patient membership, CVS executives said in an earnings call in August.

Oak Street ended the quarter with 207 centers, a rise of 30 centers from last yr, executives added. 

“Why do away with them once they’re still strategic in nature?” Tanquilut told CNBC, adding that it could be difficult to search out a buyer for Oak Street given the difficult marketplace for primary care centers.

If CVS doesn’t undergo a breakup, the “single best value-creating opportunity” for the corporate is addressing the continuing issues on the insurance side of the business, in keeping with Leerink Partners analyst Michael Cherny. 

He said the segment’s performance has fallen wanting expectations this yr resulting from higher-than-expected medical costs — by far the largest hit to the corporate’s financial 2024 guidance and stock performance, he said. Cherny said he’s confident the difficulty is “fixable,” but it can depend upon whether CVS can execute the steps it has already outlined to enhance margins in its insurance unit next yr. 

Aetna includes plans for the Reasonably priced Care Act, Medicare Advantage and Medicaid, in addition to dental and vision. Medical costs from Medicare Advantage patients have jumped over the past yr for insurers as more seniors return to hospitals to undergo procedures they’d delayed through the Covid-19 pandemic, akin to hip and joint replacements. 

Medicare Advantage, a privately run medical insurance plan contracted by Medicare, has long been a key source of growth and profits for the broader insurance industry. Greater than half of Medicare beneficiaries are enrolled in those plans as of 2024, enticed by lower monthly premiums and further advantages not covered by traditional Medicare, in keeping with health policy research organization KFF. 

But investors at the moment are concerned concerning the skyrocketing costs from Medicare Advantage plans, which insurers warn may not come down anytime soon. 

Cherny said CVS faced a “double whammy” in Medicare Advantage this yr, grappling with excess membership growth at a time when many seniors are using more advantages. 

In August, CVS also said its lowered full-year outlook reflected a decline in the corporate’s Medicare Advantage star rankings for the 2024 payment yr. 

Those crucial rankings help patients compare the standard of Medicare health and drug plans and determine how much an insurer receives in bonus payments from the Centers for Medicare and Medicaid Services. Plans that receive 4 stars or above receive a 5% bonus for the next yr and have their benchmark increased, giving them a competitive advantage of their markets.

Last yr, CVS projected it could lose as much as $1 billion in 2024 resulting from lower star rankings, the corporate disclosed in a securities filing. 

But things may begin to look up in 2025. 

For instance, one among the corporate’s large Medicare Advantage contracts regained its four-star rating, which is able to “create an incremental tailwind” in 2025, CVS executives said in August. 

“We’re giving them the good thing about the doubt because we all know that the celebs rating bonus payments will come back in 2025,” Tanquilut said. 

During a conference In May, CVS said it could pursue a “margin over membership” strategy: CVS CFO Tom Cowhey said the corporate is ready to lose as much as 10% of its existing Medicare members next yr in an effort to get its margins “back on course.” 

The corporate will make significant changes to its Medicare Advantage plans for 2025, akin to increasing copays and premiums and cutting back certain health advantages. That may eliminate the expenses tied to those advantages and drive away patients who need or need to use them. 

Those actions will help the corporate achieve its goal of 100- to 200-basis-points margin improvement in its Medicare Advantage business, CVS executives said in August.