Medicare Part D Business Acquisition to Boost CVS Caremark

NEW YORK ( Trefis) -- CVS Caremark ( CVS) ended last year with the announcement of its acquisition of Universal American's Medicare Part D business for $1.25 billion, making it the largest provider of prescription drug services for Medicare recipients. Since its inception in 2006, Medicare Part D has extended coverage of prescription drugs to senior citizens and to those who otherwise qualify through disability and its current enrollment exceeds 28 million. CVS competes with Walgreens ( WAG), Rite Aid ( RAD) and Wal-Mart ( WMT).

CVS Caremark is the largest pharmacy services provider in the U.S., managing over a billion prescriptions via its network of more than 64,000 partnering retail pharmacies including its own 7,025 retail pharmacy stores, 569 of which house retail health clinics, MinuteClinic. As the leading pharmacy benefit manager, CVS Caremark extends mail order pharmacy services, claims processing, and prescription plan design and administration on behalf of plan sponsors, which include corporations, insurance providers and the government.

We estimate that the Pharmacy Benefit Management segment constitutes about 19% of our current $38 Trefis price estimate of CVS Caremark's stock with prescription drug sales making up for over 51% and OTC drugs and general merchandise such as cosmetics, convenience foods, photo finishing, etc. contributing another 29% to its stock. We believe this acquisition could have far-reaching implications on CVS Caremark beyond its pharmacy benefit services leg of business.

Rapid growth in plan members

While the acquisition adds another 1.9 million Medicare prescription drug plan members to CVS's already existing 1.2 million members, it also increases CVS Caremark's presence in the fastest growing niche within pharmacy benefit management industry, which is Medicare coverage. Driven both by an aging demographic and the growing trend of retirees shifting from employer-based coverage to Medicare, we expect an increasing proportion of U.S. population to receive prescription coverage under the federally subsidized prescription benefit program. This will translate into an accelerated growth in the number of mail order pharmacy claims and the number of pharmacy network claims processed by Caremark.

Improvement in gross margins on increase in prescription sales

Higher drug volumes as a result of increase in the number of plan members shall enable CVS Caremark to draw deeper discounts from drug manufacturers. With the result, we foresee improvements in gross margins going forward.

This acquisition brings an older section of the population, which consumes on average 40-50 prescriptions per year. Since not all drugs are covered by the prescription plans, this presents an upside to the sale of prescription drugs outside the coverage. Here again, CVS Caremark could push the lower-priced generic substitutes to the costlier prescription drugs while earning a higher margin from the sale of generics in the process.

Another characteristic of the aging population is its preference for face-to-face interaction with the pharmacist over ordering drugs online or over the phone leading to higher footfalls in CVS Caremark retail stores. This shall translate into higher sales of OTC drugs and general merchandise per square footage of CVS Caremark's retail stores.

You can see a detailed analysis of our $38 Trefis price estimate of CVS Caremark's stock here.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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