Fiona Nanna, ForeMedia News

6 minutes read. Updated 10:10AM GMT Sat, 5 October, 2024

Shares of CVS Health have plummeted by over 20% in 2024, impacted by higher-than-expected medical expenses in its insurance division and pharmacy reimbursement pressure. As the company looks to regain Wall Street’s trust, it is considering a dramatic restructuring — potentially splitting its retail pharmacy and insurance units. However, such a move may involve substantial risks that could alter the future of this healthcare giant.

CVS Health: A Tough Year, A Tougher Choice

CVS Health is at a crossroads. Amid mounting challenges, the company has engaged advisors in a strategic review to explore the possibility of splitting itself into separate entities, CNBC reported earlier this week. This strategic review comes after years of investment aimed at transforming CVS into a one-stop health destination, including its acquisitions of health insurer Aetna and pharmacy benefits manager (PBM) Caremark.

If CVS goes through with the split, it would unwind years of integration, which have been the foundation of its current business model. Notably, CVS has spent tens of billions of dollars over the last two decades to create a diversified healthcare services platform — from owning pharmacy locations to providing insurance and operating a PBM. The vertical integration of these businesses was supposed to drive growth and stability; yet now, splitting these units appears to be a serious consideration.

However, some analysts caution that a breakup may be both complicated and risky. CVS’ integrated business model, which includes retail pharmacy services, health insurance plans through Aetna, and Caremark’s pharmacy benefits, provides considerable synergies. Severing these links could diminish CVS’ overall competitive advantage, ultimately reducing customer loyalty and, by extension, revenue.

Rajiv Leventhal, senior analyst at eMarketer, articulated his skepticism, noting that splitting CVS would likely create an imbalance, with one division possibly flourishing while the other struggles. The risk, therefore, is clear: breaking up the integrated business could do more harm than good.

Engaging with Investors: The Glenview Connection

Amid this uncertainty, CVS executives, including CEO Karen Lynch, recently met with major shareholder Glenview Capital to deliberate potential solutions for turning the business around. Glenview, however, has denied speculations that it is advocating for a breakup of CVS.

For CVS to continue as a single entity, it will require substantial restructuring. The company is already implementing a $2 billion cost-cutting initiative announced in August, which includes laying off 3,000 employees. This move is part of an effort to recover margins and secure future profitability.

Despite these cost-cutting efforts, analysts suggest that the primary area CVS needs to fix is its insurance business, which is weighing down its performance. It was no surprise, therefore, when Lynch assumed control of the company’s insurance division earlier this year, replacing then-president Brian Kane.

The Caremark Puzzle: Would a Split Make Sense?

CVS’ Caremark sits at the intersection of its pharmacy operations and insurance unit, adding value to both. Any decision to separate this segment would come with significant operational risks. Many clients currently engage with CVS across its different units, and splitting these might lead to contractual complications and potential revenue loss, according to Evercore ISI analyst Elizabeth Anderson.

“The strategy itself is still vertical integration,” says Jefferies analyst Brian Tanquilut, who believes that a breakup at this stage could be premature. “The execution might not have been the greatest, but I think it’s a little too early to conclude that it’s a broken strategy.”

Furthermore, Caremark also plays a role in funneling prescriptions to CVS’ retail pharmacies, giving CVS an edge over its primary competitor, Walgreens. A separation of Caremark would expose CVS’ insurance arm, Aetna, to greater competitive disadvantages since other major healthcare players like UnitedHealth Group, Cigna, and Humana have similar PBM models to create integrated healthcare solutions.

The Rocky Road for Retail Pharmacies

Retail pharmacy businesses are currently facing declining profitability, largely attributed to falling reimbursement rates for prescriptions. Compounding this issue, increased competition from Amazon and other retailers has intensified market pressure. Despite CVS’ recent steps to optimize its retail footprint, including the closure of 900 stores, these changes may not be sufficient to counteract the prevailing headwinds.

Analyst Brian Tanquilut suggests that a spinoff of CVS’ retail pharmacy operations is more likely than an outright sale, particularly because the retail pharmacy business might struggle to attract a buyer in a challenging market. “Why break it up when the relationship between Caremark and CVS retail is what keeps it outperforming the rest of the pharmacy peer group?” asks Tanquilut.

The Oak Street Health Question

Adding to the complexity, CVS has other significant assets, such as its $10.6 billion acquisition of primary care clinic operator Oak Street Health and $8 billion purchase of Signify Health, an in-home care provider. Theoretically, Oak Street Health could be spun out with Aetna if the company splits, but there is no straightforward solution.

Oak Street Health aligns well with Aetna’s Medicare services, providing routine screenings and care for older adults. CVS has also started to integrate Oak Street Health clinics alongside its retail pharmacies, which creates further complications for a potential breakup.

“Why get rid of them when they’re still strategic in nature?” Tanquilut pondered, pointing out that both Oak Street Health and Signify Health are currently meeting their financial targets.

Insurance Woes: CVS’ Achilles Heel?

Whether CVS chooses to split or remain intact, the biggest challenge lies in the performance of its insurance unit, primarily the Medicare Advantage segment. High medical costs related to Medicare Advantage are dragging down financial performance, with patients returning for delayed procedures like hip replacements. Medicare Advantage, a critical growth engine, has become a double-edged sword for CVS — offering high enrollment but also skyrocketing costs.

The company recently reported losing star ratings for its Medicare Advantage plans, a major blow that could potentially cost up to $1 billion in revenue for 2024. Fortunately, CVS has since regained its four-star rating on one major Medicare Advantage contract, which could provide some financial relief moving into 2025.

In a recent conference, CVS outlined plans to prioritize margin improvements over membership growth, even at the cost of losing some members in the coming year. These changes will likely involve higher premiums and reduced benefits, which could help control medical expenses and enhance the insurance unit’s profitability.

Looking Forward

As investors eagerly await the company’s November earnings call for greater clarity, it remains uncertain whether a breakup or restructuring would provide CVS with the lifeline it needs. Amid all the turmoil, one thing is clear — CVS must tread carefully. The path ahead, regardless of whether the company remains intact or splits, will require strategic and well-executed plans to safeguard its role as a dominant player in the U.S. healthcare industry.

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CVS Health is considering a major breakup to counter rising medical costs and falling profits. Learn why a split might be risky for the U.S. healthcare giant and what this could mean for investors.