Behind the Potential CVS-Aetna Deal

By Sharon Terlep and Anna Wilde Mathews Features Dow Jones Newswires

CVS Health Corp. is reportedly in talks to buy Aetna Inc. for more than $66 billion. Here's a look at what these companies do and where they match up.

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What is CVS?: CVS is the second-biggest drugstore chain behind Walgreens Boots Alliance Inc., and its 9,700 locations are the most publicly visible part of the company. But the bulk of CVS's revenue and profits come from health care, whether it is selling prescriptions at stores or through the mail, or managing drug benefits for employers and insurers.

CVS is a dramatically different company today than before its 2006 acquisition of pharmacy-benefit manager Caremark RX. The year before that deal, CVS reported $37 billion in sales for the year. Last year that number was $178 billion, with more than half coming from its pharmacy-benefit operations.

What is Aetna?: Aetna is the third-largest U.S. health insurer, with revenue last year of about $63.2 billion. Its biggest client base traditionally has been among employers, which use Aetna to provide their health benefits. But, like other insurers, Aetna has been moving further into government business. It has a growing membership in Medicare plans, which seniors can choose instead of the traditional, government-run version of the benefit. It also manages Medicaid plans, under contracts with states.

Earlier this year, Aetna had to break off a planned $34 billion deal to buy Humana Inc., a giant in the Medicare business, after losing an antitrust case. That has left the insurer to plot other sources of growth, and Aetna has pointed to potential deals as well as organic expansion of its government franchises, among other areas. Aetna has pulled back from the Affordable Care Act's exchanges, which had at one point been seen as a potential growth driver but actually produced mainly red ink for the company.

A combination with CVS would let Aetna push further into the health-care-delivery space, as well as integrating the health coverage it provides with all of CVS's pharmacy-focused services and clinics.

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What does a pharmacy-benefit manager do?: Called PBMs, these are middlemen in health care that help select which drugs are covered for patients and negotiate discounts with drugmakers. PBMs usually work for employers and health plans, using their size to negotiate discounts and rebates with pharmaceutical companies and drugstores. They keep a portion of those rebates for themselves.

The businesses have come under scrutiny over how or whether they generate savings in the system and whether savings are passed down to consumers. Insurer Anthem Inc. has sued pharmacy-benefits manager Express Scripts Holding Co. for allegedly overcharging on prescription drugs over several years. Express has denied the allegations and made counterclaims.

CVS and Aetna already have a deal together. How does that work?: Aetna became the biggest customer of CVS's PBM unit under a 12-year deal struck in 2010 between the two companies. Aetna retained ownership of its pharmacy-benefit manager, while CVS took over administration of drug spending. The idea: CVS's giant pharmacy-management business would be better positioned than the insurer to win discounts from drug companies. CVS also manages Aetna's mail-order pharmacy business.

Why would CVS want to get deeper into the health-care business?: Retail is an ever-smaller part of CVS's business. CVS said retail sales, which includes stores, online pharmacy websites and long-term-care pharmacy operations, generated $81 billion in revenue for the company in 2016. Of that revenue, roughly three-fourths was from the sale of prescription drugs. That means store sales of items from candy to cosmetics contributes relatively little to the company's bottom line.

Furthermore, the real growth opportunity for CVS is in the pharmacy-benefits business. Revenue and profits for CVS's pharmacy-services operations, comprising mainly the PBM business, have been growing at a faster clip than the company's retail business. Pharmacy-services revenue jumped 20% in 2016, compared with a 13% jump for retail operations, even factoring in CVS's acquisition of Target Corp.'s pharmacy and clinic business.

Write to Sharon Terlep at sharon.terlep@wsj.com and Anna Wilde Mathews at anna.mathews@wsj.com

(END) Dow Jones Newswires

October 27, 2017 15:01 ET (19:01 GMT)