decision to buy
, announced Monday, says as much about the state of online drug store start-ups as it does about CVS's individual prospects.
"The concern six months ago was that the .coms would put traditional drugstores out of business," says Eric Bosshard, an analyst with
. CVS's acquisition of Soma, one of a handful of companies attempting to crack the online health care business, "says to me that online companies can't go it alone." He rates CVS a market perform, and his firm hasn't provided any underwriting services for the Woonsocket, R.I.-based company.
CVS is buying Soma for $30 million -- a paltry sum considering the stock market valuations of some newly public Internet companies. Several months ago,
paid roughly $40 million, by some industry estimates, for a 46% stake in
. Amazon.com hasn't disclosed financial details of the deal.
Just what CVS is getting for its money remains unclear, however, since Soma is a private company and, as such, is exempt from filing detailed financial statements.
CVS shares climbed 1/2 to 46 Monday.
Larry Zigerelli, CVS's executive vice president of corporate development, declined to comment in detail on Soma's financial condition. But he did say that sales are growing at a 27% clip each week.
"The overall sales trends are consistent with what we estimate the other pure-play companies are delivering," Zigerelli says.
Steven Schuster, who runs
Gemina Capital Management
, a New York hedge fund that has a large holding of CVS shares, applauds the move. "This is an in-your-face move to the .coms," he says. "For $30 million they just ate up a pioneer."
But some online drug stores discount the talk that they can't go it alone in the battle with traditional drugstores. "We don't feel the need to partner," says Stephanie Schear, co-founder of privately held
Soma will be run as an independent subsidiary and will maintain its headquarters in Seattle. CVS will combine aspects of Soma's site with its own and relaunch a single site in the next few months under a new name that has yet to be determined, Zigerelli says. Because CVS had planned to spend roughly the same amount of money as it's spending to develop its Web site internally, the deal isn't expected to cut earnings this year, analysts say. Zigerelli says the acquisition will contribute to earnings next year.
Even though the words Internet and profitable are rarely used in the same sentence these days, CVS does have certain advantages that could help it meet its goal.
"Most Internet businesses lose a majority of their money from marketing," says Bosshard at Midwest Research. CVS, by contrast, expects to market its Web site within the confines of the $200 million it annually spends to promote its stores. That means the Web site's logo will appear on the 750 million shopping bags that CVS distributes each year. The site will be advertised in weekly newspaper circulars that reach 33 million people and on television ads that are broadcast to 86 million households annually, CVS says.
Furthermore, Zigerelli says CVS's existing marketing budget has room for Internet-specific advertising as well. He says the company is in talks with several portals and is looking to form an alliance with a health care content provider.
"We'd only spend incrementally if the costs are justified and will drive financial payouts," he says.
In buying Soma, CVS will leapfrog competitors
-- two other leaders in the $150 billion drugstore business. Both have been working to upgrade their online efforts. On a conference call to discuss the deal, Tom Ryan, CVS's chief executive, said buying a site that was already up and running places CVS four months ahead of its internal schedule.
"There is more pressure now for Rite Aid and Walgreen to get into the game," says Bosshard at Midwest Research.
Walgreen, by contrast, has a Web site that's mainly informational. While customers can refill their prescriptions online, they must pick them up in stores. But the Deerfield, Ill.-based company is planning to upgrade its offerings by year-end to include a full prescription service and other health and beauty items, says spokesman Michael Polzin. As for Walgreen's decision to build rather than buy a Web site, Polzin says: "We prefer to grow internally rather than through acquisitions. It's worked well for us with our stores. And we're taking the same approach online."
Rite Aid, based in Camp Hill, Penn., didn't return a phone call seeking comment.
Even with most of the major real-world players validating the Internet by devoting more energy to culling customers online, the Web may still prove a tough sell. For instance, Soma is offering a $25 credit to customers who fill prescriptions online.
Zigerelli says he doesn't foresee CVS relying on such steep discounts. Instead the company will use loyalty programs that reward both in-store and online shoppers. He notes that CVS already allows customers to refill prescriptions via an automated phone service. After one year, the service now accounts for about half of CVS's refills. Zigerelli expects online sales to reach 5% of CVS's total revenue in three years -- not an outsized share. Last year, CVS had sales of $15 billion.
"The traditional retail pharmacy business will remain the cornerstone for many years to come," Zigerelli says.
Perhaps. Either way, young .coms no longer have the luxury of building their brands for three years before real-world competition strikes.