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Aetna Uncertainty Is Keeping CVS Stock Way Undervalued

James Brumley

It’s an odd development to say the least, but a development nonetheless. Federal judge Richard Leon is attempting to prevent the merger of drugstore chain CVS Health (NYSE:CVS) and health insurer Aetna, even though the merger has already been consummated, with Aetna’s value being folded into the price of CVS stock in late November.

CVS Stock

Source: Mike Mozart via Flickr

Although rare, companies have been forced to unwind completed mergers before. They’ve never been forced to do so using Tunney Act proceedings, however, and legal experts doubt Leon’s efforts will gain much traction.

They could prove to be a drag on the CVS story, however, which is already lugging around too much dead weight.

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Healthcare Mergers Are Common

It’s not the first melding of unlike healthcare organizations we’ve seen of late. Cigna (NYSE:CI) now owns Express Scripts, and HCA Healthcare (NYSE:HCA) has completed its purchase of Asheville, North Carolina’s Mission Health. Even Amazon.com (NASDAQ:AMZN), JPMorgan Chase (NYSE: JPM) and Berkshire Hathaway (NYSE:BRK.B) are teaming up to create a new healthcare outfit intended to cost-effectively serve all three organizations’ employees.

The common thread among these and dozens of other similar partnerships, of course, is an effort to combat the rising costs of providing healthcare. In most instances, the pairings were allowed to take shape with little fanfare.

For reasons that remain mostly unclear, however, this particular deal has prompted a judicial pushback.

District Judge Richard Leon’s Merger History

The name Richard Leon may ring a bell with some investors. The U.S. district judge is the same that oversaw the Department of Justice’s effort to quell the merger of AT&T (NYSE:T) and Time Warner.

Leon was largely criticized following his ruling, not just for allowing it to take shape, but for allowing it to take shape without adding any conditions.

That’s not his only controversial case, however. Indeed, Leon has left a trail of controversial (and often overturned) rulings behind in his career, including politically-charged ones.

And, while it would be easy to chalk the judge up as a politically-motivated hack, it would also be unfair; he’s proven helpful to not just both political parties, but both philosophical schools of thought. The AT&T deal with Time Warner raises many of the same concerns being raised by the union of Aetna and CVS.

The crux of the still-unanswered question is the consent decree that calls for CVS to sell its Medicare Part D business to WellCare Health Plans (NYSE:WCG), while still remaining WellCare’s pharmacy benefits manager. Leon’s concern “is whether or not the pharmaceuticals will be [offered to WellCare customers] at a lower price and whether they’re going to be more readily accessible.”

Still, to kill the deal at this point would step far out of the bounds of the consent decree process as it’s been established. It would also step out of the accepted bounds of Tunney Act hearings. At best, says former DOJ antitrust attorney Andrea Agathoklis Murino, Leon “can say the remedy was insufficient,” forcing CVS to do more than simply shed its Medicare D arm.

Bottom Line for CVS Stock

The development makes for thrilling headlines, though Leon’s lacking legal teeth if his intent is to undo what’s already been done. All the same, the renewed court battle which could last well into the summer not only serves as a nuisance but keeps shareholders uncertain as to what the company may look like a year from now. That, in turn, is keeping the value of an already-beaten-down CVS stock suppressed.

What’s largely being overlooked in the legal melee, however, is that such a worst-case scenario has already been more than priced in.

As of its most recent look, CVS stock is trading at a dirt cheap forward-looking P/E ratio of 7.6. Even if Aetna and CVS are forced to completely split again, which is unlikely, CVS remains one of the top remaining players in the pharmacy and PBM space, if for no other reason than attrition of its rivals. The more plausible outcome of a deeper separation of its Medicare business, ultimately, could prove to go unnoticed by investors.

It’s certainly a trade against the current grain but surrounded by doubts and questions, CVS stock looks like a compelling contrarian trade here for investors willing to hunker down for the long haul.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.

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