Over the entrance of what looks like a regular, aging CVS drugstore outside Houston, a billowing blue banner announces “HealthHUB Come Inside!” Greeting folks at the door is Jesse Gonzalez, the care concierge who, in his words, “navigates” folks to the right aisle or therapist. Sleep apnea problems? Gonzalez dispatches the heavy snorers to the respiratory therapist, who can suggest a home-testing regimen and, if appropriate, recommend a CPAP mask that’s in stock to stop the honking. Fretting over excessive fatigue and weight gain? He’ll guide you to a nurse practitioner who’ll draw blood to test for thyroid disorder and, if that’s the finding, prescribe a hormone therapy you can pick up at the pharmacy counter.
On an April morning, I followed Gonzalez down a curving parquet pathway, through this stucco box that’s been repurposed as health care’s new front door for America’s communities. This store in Spring, a working-class neighborhood north of central Houston, has eliminated aisles that once offered the likes of mops and greeting cards so that a full one-fourth of its footprint is now devoted to wellness. The entire left side features products supporting the new mission, from health food—think turmeric powder shakes—to mobile equipment, such as shower chairs, usually found in warehouse stores.
The HealthHUB section at the far end goes far beyond what you’d find at a typical walk-in clinic. They offer testing and treatment for chronic conditions, and boast four consultation rooms equipped with exam chairs and retinal cameras for diabetes screening. Video screens display prices for popular services: Today’s rates are $100 for diabetic retinopathy imaging and $89 for a cholesterol screening. Employees from the Texas Department of Transportation get full physicals here. At the pharmacy adjacent to the HealthHUB, pharmacist Alex Ybarra counsels patients in a private office as part of the new high-touch approach; the previous day, she spent an hour advising a senior who needed help measuring the effect of his six diabetes medications on his blood sugar. The HealthHUB is Jacqueline Haynes’s destination for wellness. She was given a blood test for hypertension by a nurse practitioner, who wrote a prescription for beta-blocker Bystolic that Haynes filled at the pharmacy, steps away. She credits the full-time dietitian with helping her shed 72 pounds since January. “That brings my weight to 167.7,” says Haynes, who frequents a CVS “gentle yoga” class on Tuesdays. “I was addicted to avocados and chocolate. He got me eating healthy by doing things like substituting low-cal cacao nibs when I craved candy bars.”
The HealthHUB concept marks a forward leap in what’s already a revolution in health care: bringing treatment once dominated by giant hospitals and overbooked doctors’ offices to America’s neighborhoods via urgent care outlets, outpatient surgery centers, and quick care outlets in pharmacies. CVS Health claims to be both the most local and the most comprehensive.
To bolster that strategy, CVS—which has been building its own walk-in clinics for over a decade, providing simple treatments like vaccinations and flu shots—just became the first major drug retailer to combine with an insurer. In late November, CVS bought Aetna , America’s third-largest insurance carrier, in a $70 billion megadeal that made the new CVS the world’s largest publicly traded health care company, a distinction that, until now, had gone largely unnoticed. CVS ranks eighth on the Fortune 500 list, but look for it to make a big jump on next year’s roster. Had Aetna’s revenues been included for the entire year, instead of just the one month it was owned by CVS, the combined company would have posted sales of $256 billion and catapulted to fourth place behind Walmart , Exxon Mobil , and Apple .
The CVS purchase of Aetna was the largest merger of 2018, edging another health care milestone, Cigna’s $54.4 billion acquisition of Express Scripts . But this big deal is totally unlike the usual combinations of oil, mobile communications, or media giants that provide their customers with similar products and services. The CVS-Aetna union brings together two distinct, and heretofore separate, fields of health care: an insurer that’s a master of IT, deploying machine learning and A.I. to predict the next step for a vast population of enrollees; and an old-line, brick-and-mortar merchant, a marketing machine that uses displays, promotions, and coupons to get people to buy everything from drugs to cosmetics. Of all the big health care mergers, this bet that marrying big data and neighborhood drugstores will create a healthier America is the most daring—and the riskiest.
Today the master plan is to combine Aetna’s claims data and analytics that identify which of its 22 million members are at risk for, say, developing diabetes or cardiac disease, with CVS’s capacity to guide them to testing and treatment before the disease progresses, at the pharmacies and HealthHUBs. That formula is targeted to generate big savings by curbing readmissions to hospitals and getting patients to adhere to their drug regimens. Phase 2 consists of recruiting CVS’s biggest customers, mostly other insurers, to adopt a fresh model that gives CVS a share of the potentially giant savings to come from counseling and screenings at their corner clinics that keep patients out of operating and emergency rooms.
Investors, however, think it’s CVS that could use a checkup. Its stock’s steep slide over the past three years is a reversal from a long history of outperformance. Over the decade through 2015, CVS delivered total annual returns of 15.3%, double the trend for the S&P 500. The cratering started in the spring of 2016, then accelerated after reports of an Aetna deal surfaced in October of 2017. Since CVS’s decline began, its stock price has dropped 28%, from $76 to $56.
The problem is twofold. First, Wall Street is judging that CVS way overpaid for the insurer. When rumors of a merger spread, the companies’ combined market caps stood at $128 billion. Today that figure is $72 billion, meaning that a staggering $56 billion, or 44% of the total, has vanished. The rub is that CVS paid a 32% premium for Aetna and, in the process, loaded an additional $78 billion in capital on its books.
Second, CVS did this deal just when its own core businesses were deteriorating. Hence, it’s so far generating weak returns on all the extra capital added by purchasing Aetna. A good measure of how far the performance has declined is Economic Value Added, a tool deployed by research firm ISS EVA, a branch of governance adviser Institutional Shareholder Services. EVA measures whether companies are earning their “cost of capital,” the minimum requirement for rewarding investors. In the year prior to the merger, CVS had net operating profit after tax (NOPAT) of $7.7 billion, and Aetna achieved $3.3 billion, for a total of $11 billion, numbers that both easily beat their 5.4% cost of capital, though the CVS figure was already sliding. Bennett Stewart, a senior adviser to ISS, reckons that the new CVS would have needed to earn $1.1 billion more, or $12.1 billion, just to break even on the big premium paid for Aetna. The rub is that the combined enterprise is making not more, but less now than in 2018 when the deal closed. For 2019, based on CVS’s generally negative guidance, analysts predict that it will earn just $10.5 billion in after-tax operating income for this year, $500 million below 2018, and $1.6 billion less than the amount needed to achieve an adequate return on the Aetna deal.
Sounds bad. But keep in mind that investors have radically marked down CVS stock. So what matters now is how its future earnings compare with its beaten-down price. “The expectations are so low that if CVS meets that reduced $10.5 billion forecast and improves from there, our models show that its stock is undervalued by as much as 80%,” says Stewart. By valuing CVS at a lowly $72 billion, investors are forecasting that it merely achieves mediocrity.
But the team at CVS had much bigger aspirations in mind.
A merger that has not equaled profits
The $70 billion merger with Aetna made CVS the world’s biggest health care company, with projected revenues of $250 billion in 2019. But so far it hasn’t paid off. In the first quarter of 2019, the new CVS posted profits one-third lower than the amount the two companies had earned separately a year earlier. An integration plan targeting $750 million in savings should help lift profitability.
In his office at CVS’s campus-like headquarters in the sleepy town of Woonsocket, R.I., CEO Larry Merlo is making his case: namely, that the big price for Aetna was deserved because the combination will establish a new paradigm for health care. “We don’t look at this as overpaying,” says Merlo, a folksy, mustachioed former pharmacist who famously banished tobacco products from his stores in 2014. “It’s a tremendous opportunity to transform the health care experience, to put the community at the center of care.” Indeed, on a May 1 conference call in which CVS announced better-than-expected results, Merlo discussed plans to make HealthHUBs the cornerstone of the new CVS. Investors liked what they heard. Shares surged 5.4%, adding almost $4 billion in value.
CVS is relying on two pillars to make its convenience-store approach to health care a success. The first is its giant footprint. It operates 9,900 drugstores, standing in a virtual tie with Walgreens as the nation’s largest drugstore owner. Eighty percent of America’s families need to walk or drive 10 miles or less to reach a CVS. Today, it’s already running 1,100 MinuteClinics, which provide such basics as flu shots and shingles vaccinations, more than twice the number of walk-in outlets in Walgreens stores. Walmart, the No. 3 pharmacy owner, has just a smattering of in-store clinics in three states. In early May, CVS unveiled plans to grow its three Houston HealthHUBs to 20, or one for every seven stores in the metro area, and pledged to announce a bigger rollout plan in June. If CVS applies the same “hub-and-spoke” ratio nationwide that it now uses for the MinuteClinics by expanding the existing MinuteClinics into HealthHUBs—and analysts think that’s likely—a HealthHUB, by Fortune ’s calculations, could be within 10 miles of three-quarters of America’s homes.
The second mainstay is the clout of a giant insurer. The new CVS-Aetna is a colossus that combines the pharmacy industry’s three major areas: retail stores, insurance, and a pharmacy benefit manager (or PBM, which manages prescription drug plans). America’s largest insurer, UnitedHealth Group , operates a PBM, physicians’ practices, and about 200 walk-in clinics, but no retail stores. Walgreens partners with a PBM but doesn’t own an insurer, and fifth-ranking insurer Cigna recently acquired the largest PBM—Express Scripts—and runs HMOs but doesn’t operate neighborhood clinics. The new CVS is focusing on where the money is: managing chronic conditions. Between 50% and 60% of all adults suffer from one or more of the top five: diabetes, hypertension, cardiac disease, depression, and asthma. Those conditions account for 80% of America’s $3.5 trillion in annual health care spending.
The new model’s Rx is to hand Aetna’s data on every detail of its members’ health—including hospitalizations, lab tests, and doctors’ diagnoses—to the pharmacists and wellness specialists who encounter those folks in person far more often than anyone else in their health care orbit. Aetna’s analytics, deploying artificial intelligence, also tell the HealthHUBs’ front line who, from genetics and medical history, is more likely to contract the conditions. “The average adult visits the doctor 1.6 times a year,” says Merlo. “People pick up prescriptions a lot more often than they see a physician.”
Still, CVS must proceed cautiously to avoid either crossing legal boundaries governing consumer privacy or provoking customers’ perception that it knows too much about them. A thicket of state and local laws mandate that only employees directly involved in providing or assessing patient care can view medical histories—meaning marketing teams at Aetna can’t review prescription histories from CVS. Regulations also limit who is able to prescribe and perform tests, and restrict data-sharing for HIV and mental health patients. Privacy advocates are already raising concerns about mixing insurance and retail histories. “It’s a way to leverage more revenue from patients by steering them to their own more expensive pharmacies because CVS will know everything about them,” says Dr. Deborah Peel, a psychiatrist who is president of the advocacy group Patient Privacy Rights.
It’s clear there are efficiencies to be gained from bringing many of those primary-care functions to the local drugstore. But Merlo has another, bigger idea: He wants insurers and HMOs to pay CVS to keep people healthy.
In the pharmacy business, no mechanism now exists for sharing savings,” says Kevin Hourican, chief of the $83 billion retail pharmacy business at CVS. The company’s game plan to change that? “We’ll do it internally with Aetna to prove we can do it ourselves, then bring it to the other big insurers.” Hourican notes that a quarter of the 7 million hospital readmissions each year are preventable, and that most are caused by patients who either don’t take their chronic-care medications or take them incorrectly. The return visits, costing $14,000 on average, could be sharply reduced through the type of counseling offered at the HealthHUBs. “If I can save an insurer $10,000 by preventing Ms. Jones from going back to the hospital, I want to share x percent of the savings,” says Hourican.
That’s key, because an important part of CVS’s business is in decline: reimbursements. “The trend from the plans is, ‘Last year we paid you $10—next year we’ll pay you $9,’ ” says Hourican. Result: unremitting pressures on margins. That, in turn, is due to a convergence of factors. New generic drugs are typically reimbursed at three times the rate of branded drugs. But the flow of generics has slowed in recent years, in part because their share of total prescriptions has already soared to around 90%. Drugstores are also suffering from a shift to “specialty” drugs that cost $10,000-plus a year, treat such complex diseases as rheumatoid arthritis and hepatitis C, and are typically dispensed at separate pharmacies or by mail.
But there are also significant changes happening in the PBM, or pharmacy benefit manager, world. And it’s a world where CVS is a major player, thanks to its 2007 acquisition of Caremark, which has grown fast under CVS’s ownership. Since 2012, Caremark’s operating profits jumped by 75% to $4.7 billion, and consulting firm Grand View Research predicts that the PBM industry will double in size to $750 billion in revenues by 2026.
But Caremark and the PBM industry face a major threat that could undermine that forecast: proposed regulations that would limit what they do best, hold down drug prices. Caremark manages prescription drug plans for insurers and HMOs that pay for the drugs dispensed by pharmacies. So, in effect, Caremark tortures its own CVS drugstores, as well as the likes of Walgreens, by directing the lion’s share of their insurers’ members to the chains that accept the lowest reimbursements.
Caremark has been extremely effective in driving deep discounts for its sponsors, a group that encompasses the premerger Aetna and dozens of other big insurers and HMOs, thereby putting pressure on CVS’s retail margins. Here’s how it works: Caremark establishes “formularies,” or lists of preferred medications based on cost, that your health plan agrees to cover. The formularies guide physicians, nurses, and hospitals to prescribe—and patients to request—the least expensive drugs in any category shown to be medically equivalent. CVS, for example, always substitutes new generics identical to branded names when they become available. The PBMs pit those me-too drugs against one another, choosing the one that offers the lowest net price.
In the past three years, CVS has secured around $140 billion in rebates and held net branded drug price increases in the low single digits by wresting these bargains. Last year it replaced Sanofi’s super-expensive Lantus on its formulary with a newly approved biosimilar, Basaglar from Eli Lilly . Lantus was priced at $340 for a 30-day prescription, versus $235 for Basaglar. Three-quarters of the 27,000 affected patients switched to Basaglar and other low-cost alternatives, producing big savings for Caremark’s plans.
It’s complicated, but the new rules that threaten the PBMs, advanced by the Department of Health and Human Services, apply to Medicare and Medicaid drug plans. Under the current system, the discounts won by Caremark and its peers go almost entirely back to the insurance companies, which use the money to reduce premiums (patients’ co-pays and deductibles are still based on official “list” prices). The proposed regulations, backed by big drugmakers, would shift a large share of the discounts away from insurers and instead lower co-pays at the pharmacy counter. That would change the dynamic of this whole ecosystem. “A lot of the money that now goes to lowering premiums would go to [lowering] co-pays and deductibles,” says Joseph Antos, an economist at the American Enterprise Institute.
Today, competing plans attract seniors by offering the lowest premiums. If the proposed regulation goes through, the insurers would have less of those PBM-generated savings to put toward lowering insurance premiums, which, as Antos points out, is what seniors care most about. That would weaken the ability of the plans to gain hordes of new customers with low premiums, hence the value of the PBMs to the plans would diminish, and their fees could shift downward. “When Big Pharma universally backs a proposal, your antenna goes up,” says Merlo. Indeed, the regulations could undermine what’s been CVS’s best profit engine.
So, what could take its place?
Ten thousand people turn 65 every day,” says Aetna president Karen Lynch, 56. “It’s hard to imagine a better place for new customers.” CVS brought Lynch into the fold as part of the Aetna acquisition. And her Medicare Advantage franchise (the privately managed plans that are an alternative to Medicare) is a leading growth engine for the combined enterprise.
At Aetna, Lynch expanded the Advantage ranks from 968,000 in 2013 to 2.2 million today, and she now oversees that in addition to CVS’s giant SilverScript Medicare Part D program (the privately managed supplemental prescription drug program for seniors). Aetna was among the pioneers in providing transportation to hospitals and clinics, and it was one of the first to grant seniors acute-care service at no extra charge when they travel outside their service area. Under Lynch, who was just 12 years old when her mother committed suicide, Aetna also offered one of the most generous behavioral health programs.
Advantage is now a $20 billion–plus business and represents one-third of Aetna’s sales, yet CVS has lots of headroom. Its Advantage franchise is far smaller than those at the two leaders, UnitedHealth and Humana . But it’s gaining fast: In the first quarter, enrollment surged by 140,000, or 27%, the largest percentage increase of any big Medicare Advantage plan.
It was a big strategic stretch for CVS to go from a let’s-get-healthy drugstore chain to a never-before-seen combination that could change the future of health care. The CVS-Aetna deal is breaking ground in territory so uncharted that the results are as hard to predict. You could liken it to a trailblazing medical procedure that could save millions of lives but has yet to be tested. And to make it work, CVS will need leaders with a mastery of both sides of the business—and new ideas that bridge these two diverse disciplines.
Lynch is a case in point. She was the board’s choice to follow now-retired Aetna CEO Mark Bertolini, and she is a favorite to succeed Merlo, who’s 63. To exploit the union of a retailer and an insurer, she’s employing a concept CVS calls “Recovery in a Box.” “The prime time for things to go wrong is when people are first discharged from the hospital,” she says. Take a patient who’s just had knee surgery. Under Recovery in a Box, an Aetna care manager would message a care concierge at HealthHUB or a pharmacist to arrange transportation home from the hospital and deliver a big package containing new prescriptions, a knee scooter, a shower chair, and healthy meals for the first few days. “The current system of episodic care, where people seek care when something goes wrong, is being replaced by service where you live and shop. We’re the new front door for health care,” she says. It’s a vision born in the yoga studios and screening suites at a Houston strip mall.
But it’s coming soon to a corner near you.
A version of this article appears in the June 2019 issue of Fortune with the headline “Your Drugstore Will See You Now.”
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