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It Makes Sense For CVS Health Corp (CVS) to Buy Aetna Inc (AET)

John Divine

U.S. pharmacy giant CVS Health Corp (NYSE: CVS) has proposed a bid to acquire health insurance leader Aetna Inc ( AET) for $66 billion, or more than $200 a share, according to sources that leaked the proposed deal to the Wall Street Journal.

[See: 9 of the Market's Best Growth Stocks.]

AET stock, which was trading around $160 per share in the minutes before the report, closed at $178.60 Thursday, gaining 11.5 percent. CVS stock lost 2.9 percent and was down another 1 percent in morning trading Friday.

If completed, the CVS-Aetna merger would be the largest health care insurance deal in history. The marriage makes a lot of sense, but could the deal actually go through?

Why the CVS-Aetna deal makes sense. If CVS wants to speed up growth or strengthen its competitive grip with an acquisition, it essentially has to look outside the drugstore industry. CVS and Walgreens Boots Alliance ( WBA) are the two biggest pharmacy chains in the U.S. by light years; both have market capitalizations above $70 billion, and the next-biggest player? That would be Rite Aid Corp. ( RAD) at $1.6 billion.

Walgreens already tried to buy Rite Aid but, due to antitrust concerns, had to settle for buying less than half of its stores. The government essentially won't allow the CVS-Walgreens duopoly to become any more powerful than it already is through mergers and acquisitions.

Perhaps a more important reason for the deal from a consumer's perspective is that, in owning a major health insurance company, CVS could bargain much more effectively with drug companies on pricing. CVS, aside from being a pharmacy, is also a pharmacy benefits manager, meaning it already negotiates on behalf of insurance companies to bring down the cost of the drugs they decide to cover in their plans.

Buying Aetna would give CVS much more power in those negotiations.

"This could be a sign of doubling down on a market they know well -- the U.S. -- with somewhat of a vertical integration as Aetna is a big customer for CVS," says Chuck Gammal, a partner in the life sciences practice of Simon-Kucher, a global consulting firm.

Were Aetna to be swallowed up by CVS, it could also make for a better, healthier experience for the customer, says Larry Briski, director in West Monroe Partners' health care and life sciences practice.

"A core obstacle in care management is access to full pharmacy information and having the ability to influence taking drugs on time," Briski says. This merger would "have the ability to impact drug compliance while being integrated into the care team in an unprecedented way. While people are picking up prescriptions, we can tell them at the point of retail, they need to get a checkup or have a specific test completed."

Then there's Amazon.com ( AMZN). CEO Jeff Bezos is by this point justifiably notorious for taking his company into new industries and promptly crushing them, and it's been an open secret that one of Amazon's next big initiatives was to disrupt the prescription drug business. Given Amazon's track record, it's smart for CVS to try to get ahead of the competition sooner rather than later.

[Read: Amazon.com, Inc. (AMZN) Just Posted Its Most Impressive Quarter in Years.]

Why it might not happen. For all the sense it makes, there's still a very reasonable possibility the CVS-Aetna merger will never happen. There are already the normal risks that exist after news of any takeover bid is leaked to the press. The deal could fall apart in advanced negotiations; another company could swoop in and make a better offer for Aetna; shareholders could vote against the deal.

Then there's the antitrust risk. Would regulators fear the power of the combined company? Anthem ( ANTM), the nation's second-largest health insurer, announced the formation of a new pharmacy benefits manager with CVS only last week. If CVS also owned Aetna, the No. 3 health insurer, there's no doubt a reasonable case could be made that CVS holds too much power on the purchasing side.

The antitrust risk is perhaps the largest unknown facing this deal.

Finally, CVS has just $2.2 billion in cash, meaning it would have to borrow the remaining money or use a huge chunk of its stock to finance the deal. If it makes sense for shareholders, though, this shouldn't be a huge hurdle.

The takeaway. The great thing about the stock market is it can actually speak to you. Right now, it's telling you that it believes the deal is possible -- which is actually a nice vote of confidence considering the antitrust considerations.

But the market is also saying there's a healthy dose of risk that the deal won't happen. AET stock is trading around $175 per share near midday, about 14 percent lower than the $200 per share bid. Factoring in the time value of money and how long it could be before such a deal is approved and goes through, a 14 percent discount reflects some, but not excessive, skepticism that this deal will happen.

As an investor, it's usually very tricky to try to "play" merger arbitrage opportunities like this. It's best not to speculate one way or the other, and simply watch from the sidelines to let the deal play out.

With all the emphasis President Donald Trump has put on lowering drug prices recently -- he signed an executive order to that effect -- it actually seems like this sort of deal could help to do that. In that sense, there may be less regulatory risk than there appears to be at first sight.

[Read: Top M&A Targets in 2017.]

There's no clear-cut interpretation of whether the CVS-Aetna deal will be consummated, but if you're ever wondering what the smart money thinks, all you have to do is look at Aetna's stock price. It'll whisper to you.



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