Should You Buy It: Go Long with CVS

CVS Caremark (CVS - commentary - Cramer's Take) changed the landscape of the pharmacy retail business Tuesday night when it pledged to buy Longs Drug Stores (LDG - commentary - Cramer's Take) for $2.7 billion. The $71.50 a share price tag represents a 32% premium to the previous closing price.

CVS already has about 6,300 stores across the country, and this deal adds 521 locations in states like California, Arizona and Nevada, where the company had relatively small market share. As a result, the company is expecting limited regulatory friction.

Management expects the deal to close by the fourth quarter, but to dilute earnings until 2010. That said, through operating synergies, the company is targeting $100 million of annual cost savings from the deal in 2009, and $150 million a year after that.

CVS is no stranger to large acquisitions, as the Longs deal marks the tenth purchase that management has made in as many years, and the first since the company bought pharmacy benefit manager (PBM) Caremark last March for $27 billion. Longs has a similar PBM operation, RxAmerica, with eight million members that also comes as part of the buyout.

With that in mind, I'm here to answer readers' questions: Should you buy it? Can CVS Caremark continue to grow its retail division through the Longs purchase, or did management potentially overpay for the acquisition?

Longs was expected to post double-digit earnings growth for the fifth straight year in fiscal 2009 (ending January), but the company's operating margin in fiscal 2008 was just 3.1%, compared with 6.3% for CVS Caremark.

CVS management hopes to boost the square footage that Longs devotes to health and beauty products in the front of its drug stores, where the retailers have more pricing leverage. The scale of CVS' distribution network should also help store-level productivity for the Longs chain.

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David Peltier is a research associate at TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Peltier appreciates your feedback; click here to send him an email.

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