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3 Reasons Why CVS Health Thinks Its $78 Billion Bet Can Make You a Lot of Money

Keith Speights, The Motley Fool

CVS Health (NYSE: CVS) CEO Larry Merlo isn't a stranger to the healthcare industry's biggest event of the year. But he represented a much bigger company this time around when he spoke at the J.P. Morgan Healthcare Conference on Tuesday.

In November, CVS Health finalized its $78 billion acquisition of big health insurer Aetna. (The equity value of the deal totaled $70 billion, but CVS Health also assumed $8 billion of Aetna's debt.) As you might expect, Merlo talked a good bit about the impact of the Aetna acquisition in his presentation at the J.P. Morgan conference.

Wall Street has been skeptical about the wisdom of CVS Health's buyout of Aetna. But Merlo mentioned three specific ways that the deal could create value for shareholders. Here's how CVS Health's $78 billion bet could make you a lot of money over the long run.

Older woman holding CVS basket standing next to a pharmacist in a CVS store.

Image source: CVS Health.

1. Synergies

It didn't take Merlo very long to mention the synergies expected from the integration of Aetna into CVS Health. He stressed that a federal court's review of the deal under the Tunney Act won't impact the anticipated timeline for achieving more than $750 million in synergies in the second year following the acquisition.

Merlo said that those synergies will be attained in three ways: The combination of corporate functions is already well underway and should begin to produce savings in early 2019; further integration of the two businesses, including aligning formularies and revamping the design of health plans, is expected to start yielding benefits in the first half of the year; and medical cost savings should kick in later in 2019.

Are these synergies enough to get investors excited? Not really. They're only a drop in the bucket for CVS Health. However, Merlo understandably emphasized the savings that are expected because they're easy to explain, relatively easy to achieve, and will be visible over the near term. But synergies are basically a side benefit from the integration that he thinks will create much bigger opportunities to reward shareholders.

2. Higher profits

One of those bigger opportunities is the potential for higher profits. CVS Health makes a lot of revenue, but its profit margin is only 1.65%. Aetna's profit margin in 2017, by comparison, was over 3%. 

But exactly how will CVS Health boost its profit margins as a result of the Aetna acquisition? Merlo said to expect a significant impact on the company's front store. He stated that CVS Health plans to create "a new front door to healthcare."

That might sound like a phrase created by a marketing consultant, but Merlo gave some details on what CVS Health plans. He mentioned that the company intends to scale back on underperforming products in its stores and reallocate up to 20% of space to more profitable healthcare service offerings.

3. Faster growth

CVS Health's sales increased by 2.4% year over year in the third quarter of 2018. That's not a level to make anyone jump up and down in excitement. However, Merlo thinks the integration of Aetna will accelerate growth.

Getting to that faster growth won't be easy. CVS Health intends to improve customer engagement, improve health outcomes, and reduce total healthcare costs through a variety of initiatives. For example, Merlo said the company will integrate CVS and Aetna clinical programs to support patients during and after discharge from the hospital to reduce readmissions. CVS Health will also expand its MinuteClinic services to help patients manage chronic diseases.

If CVS Health succeeds in its efforts, it should save money for its Aetna and pharmacy benefits management (PBM) customers. That makes for happy customers who will want to stay with the new CVS Health. And it should enable the company to attract new customers as well. Put those two outcomes together and it's a formula for growth acceleration.

Short-term realities vs. long-term vision

While the long-term vision articulated by Merlo at the J.P. Morgan conference sounds promising, CVS Health faces some short-term realities that aren't so rosy.

The company took on a lot of debt to fund the Aetna acquisition. This has consequences for shareholders, including paying an estimated $3.1 billion in interest expense this year, suspending dividend hikes, and halting the stock buyback program. CVS Health is also increasing its investments as a result of the Aetna integration with the initiatives to expand service offerings.  

At the same time, CVS Health still has to deal with headwinds from last year that aren't going away. The trend of fewer high-impact generic launches will carry over into 2019. Pricing and reimbursement pressures will continue to affect the company's retail and PBM businesses. 

Merlo expects CVS Health to manage its debt effectively and lower its leverage ratio "in a timely manner." While he acknowledged the company's headwinds, he also highlighted key tailwinds, including strong retail prescription volume growth. 

If CVS Health fulfills the vision laid out by Merlo at the J.P. Morgan conference, the company will provide significant cost savings, higher profits, and faster growth for shareholders. This would mean investors who own CVS Health stock today will make more money down the road. But it could take several years before we know if CVS Health's huge bet pays off. 

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Keith Speights has no position in any of the stocks mentioned. The Motley Fool recommends CVS Health. The Motley Fool has a disclosure policy.