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Morningstar | The Combination of CVS and Aetna Creates a Franchise Protected by a Narrow Economic Moat

CVS has spent the better part of the last decade positioning itself as a leader within healthcare services--the acquisitions of Caremark, Omnicare, and most recently Aetna have defined its strategic direction. The combination of the leading PBM, retail pharmacy, and a top managed care franchise form the three pillars that we think position the firm to better compete with a consolidating healthcare services sector over the next 10 years. The cost advantages and underlying network effects that support the firm's excess economic returns are only set to strengthen as the integration of Aetna continues over the coming year. We think cost and sales synergies will likely exceed initial expectations as the firm begins to serve its customers at a lower all-in cost than rivals, increasing the attractiveness of its combined medical and pharmaceutical benefits offering.That said, we think investors will be increasingly cautious in their evaluation of potential issues arising from the transaction. The high price paid, and significant debt incurred, increases the operational risks of an otherwise largely stable franchise, in our view. Following the write-down of Omnicare during 2018 due to poor financial performance, we think there's little room for error in ensuring the Aetna acquisition sees success. This complexity is accentuated by the increasing focus in Washington toward changing the current drug pricing paradigm, opening the door to potential market disruption at Caremark and the PBM industry at large.Finally, while we expect concerns around healthcare reform to pick up over the coming quarters as the 2020 election cycle begins to unfold, we believe the firm's economic moat will help protect against policy-driven volatility. We maintain that large-scale disruption is a low-probability event and think a more likely outcome would include private service providers to play a role in any policy solution to the nation's rising cost of healthcare.