CVS Got Aetna. Next Up, Reimagining Health Care.

(Bloomberg Opinion) -- CVS Health Corp. CEO Larry Merlo is a 28-year veteran of the company who helped lead its transformation from a regional drugstore chain into a pharmacy giant. Now, after guiding CVS through its $69 billion acquisition of insurer Aetna Inc., he has the chance to cap off his career by successfully managing this expensive experiment and, in the process, creating a template for the future of American health care.

The merger creates a company that’s singular in its size and scope, combining CVS’s nearly 10,000 stores and 1,100 clinics with Aetna’s 22 million enrollees. It also includes CVS Caremark, a leader among pharmacy benefit managers. Merlo — a pharmacist by training who’s been CEO since 2011 — has said the idea is to create a more local, coordinated, and accessible “front door” to health care. “We look at the industry and we define it as one that's fragmented, and often times care is uncoordinated,” he said at a recent Evercore ISI health-care conference. He added, “It does not place enough of a focus on outcomes or managing the patient in a holistic way and all of that leads to — pick the adjective that you want to use, wasteful, avoidable, preventable spending that amounts to billions of dollars.” 

CVS Got Aetna. Next Up, Reimagining Health Care.

While Merlo, 63, may be right in identifying the problems surrounding health care today, his sales pitch for what CVS is trying to do naturally invites skepticism. Large mergers often result in firms using their power to capture more of the profit produced by America’s messy health-care system rather than trying to fix it. And the merger leaves the company heavily indebted, which will limit its maneuverability. But critics may be underestimating the potential for CVS to make an impact.

If Merlo’s vision becomes reality, it could benefit both the drugstore chain and the Aetna business, while providing savings for the company and its customers.And with Amazon.com Inc. looming as a retail and pharmacy threat — not to mention a health-care innovator in its own right, through its venture with Berkshire Hathaway Inc. and JPMorgan Chase & Co. — sticking with the status quo may be a riskier option.

CVS Got Aetna. Next Up, Reimagining Health Care.

Merlo is no stranger to big changes in the business. CVS was part of a retail conglomerate that included Kay-Bee Toys and Linens ‘n Things in his early years. And the Aetna acquisition isn’t the first time that CVS has pioneered a new business model. In 2007, the firm acquired Caremark for $21.6 billion, getting CVS into the business of negotiating drug costs for health-care providers in addition to dispensing them. 

The early days of the Caremark combination were marred by integration issues and contract losses. But Merlo, who helped  successfully absorb a number of large acquisitions of other drug chains while leading its stores, turned the acquisition around after taking over as CEO in 2011. The firm’s PBM unit is one of the largest in the country, and is an enormous source of revenue in its own right that drives much-needed traffic to CVS stores.

CVS Got Aetna. Next Up, Reimagining Health Care.

CVS Caremark is a clear fit with Aetna, the country’s third-largest insurer and previously a huge client. Bringing Aetna in house allows for further integration of drug and medical benefits for enrollees, which could deliver cost savings to both customers and the company. The added scale should grant an advantage in drug-price negotiations. That tie-up has a promising precedent in UnitedHealth Group Inc., the nation’s largest health insurer, which has used an in-house PBM to its advantage.

CVS Got Aetna. Next Up, Reimagining Health Care.

Patients with chronic diseases like diabetes often have comprehensive care plans that include drugs, diet and exercise but they too rarely follow them. That leads to  higher medical costs in the long run. The new CVS hopes to help fix that. Merlo noted in a recent speech at the Economic Club of Washington that a diabetes patient may see her doctor three or four times a year, and her pharmacist as many as 24 times. There are lots of opportunities in cases like this for a company like CVS, with coordinated and inter-connected services, to better manage health-care decisions. 

It’s no easy task, though. CVS needs to figure out how to deliver quality care in a cost-effective way at a greater scale. Right now, for example, there are clinics in only about 11 percent of the firm’s stores. And it needs to figure out how to intervene without intruding. Even stores that have clinics will need retrofitting, as they weren’t built with Aetna’s needs in mind. The company plans to roll out concept stores with more space devoted to services, but figuring out the right layout and set of health-care options will be a trial-and-error process. 

Given its debt load, CVS will be somewhat constrained in how much it can invest, and it remains committed to a significant dividend. The combined firm will generate a lot of cash and a buyback pause helps. But it also has synergy targets to meet, and there's the possibility of an economic downturn in the months ahead. The transformation will be on something of a budget at first, which may slow it down.

There’s a relatively staid version of this merger, in which it proves to be a defensive consolidation that will focus on cost cutting and leveraging its increased pricing power.  But Merlo is making the case that it can be much more than that — and 2019 will begin to show if he’s right.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Max Nisen is a Bloomberg Opinion columnist covering biotech, pharma and health care. He previously wrote about management and corporate strategy for Quartz and Business Insider.

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