The potential risks of CVS breaking up.

• One option being weighed by CVS is splitting up its retail pharmacy and insurance units, as reported by CNBC on Monday.
• Over the past two decades, the company has spent tens of billions of dollars on acquisitions to become a one-stop health destination for patients.
• If CVS separates its vertically integrated business segments, including Aetna and Caremark, it may lose customers and revenue.

It's time for a wellness check at .

The company's insurance unit and pharmacy reimbursement pressure, among other issues, have caused its shares to drop more than 20% this year.

To regain the trust of Wall Street, the company is considering splitting apart.

On Monday, CNBC reported that CVS has enlisted advisors to conduct a strategic review of its business. One possibility being considered is separating its retail pharmacy and insurance divisions. This would represent a dramatic shift for the company, which has invested heavily in acquisitions over the past two decades to become a comprehensive health care provider for patients.

Some analysts contend that a breakup of CVS would be challenging and unlikely.

If CVS separates its vertically integrated business segments, including Aetna and Caremark, it may lose customers and revenue, resulting in lower profits for the healthcare giant, which has already reduced its full-year 2024 earnings guidance for three consecutive quarters.

"Rajiv Leventhal, a senior analyst at eMarketer, stated that there is no ideal choice for a split, and he believes that a breakup is still a possibility. If it does occur, one side will experience great success and prosperity, while the other will struggle greatly."

On Monday, CVS executives met with major shareholder Glenview Capital to discuss ways to revive the struggling business and increase its stock value, according to CNBC. However, Glenview denied on Tuesday that there were any plans to split the company.

If the CVS stock price continues to decline, the management team, including CEO Karen Lynch, will need to make significant changes to address the financial issues affecting the company.

Nearly 3,000 employees will be laid off by CVS as part of the $2 billion cost-cutting plan announced in August to boost profits.

Analysts believe that the healthcare giant's stock price and financial guidance for the year are being weighed down by the need to recover margins in its insurance business. This pressure led to a leadership change earlier this year, with Lynch taking direct oversight of the insurance unit in August, replacing Kane as president.

A company spokesperson informed CNBC that CVS' management team and board of directors are always looking for ways to increase shareholder value, but declined to comment on any breakup rumors.

The spokesperson stated that the company remains committed to improving performance and providing top-notch healthcare products and services through its unique scale and integrated approach.

The company's upcoming earnings call in November may provide investors with more clarity on its future direction.

The Caremark question

Analysts believe that the likelihood of CVS separating its retail pharmacy and insurance segments is low due to the synergies between the three combined businesses. However, they also warned that doing so could come with risks.

"Jefferies analyst Brian Tanquilut stated on CNBC that the strategy itself is still vertical integration, even though the execution may not have been perfect. He believes it is premature to determine if it is a failed strategy."

According to Evercore ISI analyst Elizabeth Anderson, many of CVS' clients contract with the company across its three business units. Anderson stated that separating a whole contract in the event of a breakup could be a challenging operation that may result in lost customers and revenue.

In the U.S., drug supply chain managers like CVS' Caremark play a crucial role in the pharmaceutical industry, negotiating drug rebates with manufacturers on behalf of insurers, compiling lists of preferred medications covered by health plans, and reimbursing pharmacies for prescriptions.

Caremark's position at the intersection of CVS' retail pharmacy operation and its Aetna insurer provides a competitive advantage for both businesses. However, in the event of a breakup, it is unclear where Caremark would fall.

Having separate PBMs would put the insurance business at a competitive disadvantage since all of its largest rivals, including Aetna, also have their own PBMs, said eMarketer's Leventhal.

In some instances, Caremark channels drug prescriptions to CVS retail pharmacies, which has helped Caremark's drugstores capture a significant portion of the prescription market share, surpassing its main competitor, which has been grappling with financial difficulties as a standalone pharmacy operation.

In 2023, CVS held more than 25% of the U.S. pharmacy market share in terms of prescription drug revenue, while Walgreens had nearly 15% of that share.

To remain competitive in the retail pharmacy industry, which is facing profitability challenges due to falling reimbursement rates for prescription drugs, decreased consumer spending, inflation, and increased competition from other retailers, CVS drugstores must find ways to maintain an edge. Additionally, burnout among pharmacy staff is putting additional pressure on the industry.

The operating margin for CVS' pharmacy and consumer wellness business was 4.6% in 2022, an increase from 3.3% in 2022 but a decrease from 8.5% in 2019 and 9.9% in 2015.

Both CVS and Walgreens have shifted their focus from continuously expanding their retail drugstore stores to shutting down hundreds of locations across the U.S. CVS has completed a three-year plan to close 900 of its stores, with 851 locations already closed as of August.

According to Tanquilut, a spinoff of CVS' retail pharmacies could be more likely due to the rocky outlook for retail pharmacies, which could make it difficult for CVS to find a buyer for its drugstores in the event of a split.

Tanquilut stated that the reason for the closure of stores is because of the strong relationship between Caremark and CVS retail, which keeps it ahead of the rest of the pharmacy peer group.

Fate of Oak Street Health

In the event of a breakup, CVS has other assets that need to be distributed.

The two recent acquisitions, Oak Street Health and Signify Health, were made by CVS to further its major push into healthcare. This strategy has also been pursued by other retailers, including Walgreens, over the past few years.

In the event of a split, Aetna could theoretically spin out Oak Street Health, according to Mizuho managing director Ann Hynes, who wrote about it in a research note on Tuesday.

Aetna's Medicare business is supported by the primary care clinic operator, which provides routine health screenings and diagnoses for older adults, in addition to other services. Additionally, CVS sells Aetna health plans that offer discounts when patients utilize the company's medical care providers.

Oak Street Health is now being integrated with CVS retail pharmacies. The company has opened primary care clinics alongside some drugstore locations in Texas and Illinois, with plans to introduce around two dozen more in the U.S. by the end of the year.

Several companies, including Amazon, CVS, and Walgreens, are experiencing financial difficulties due to their investments in primary care clinics. According to Tanquilut, building clinics requires a significant amount of capital, and these locations often lose money for several years before becoming profitable.

VillageMD could potentially be sold by Walgreens, as the company mentioned in an August securities filing.

Tanquilut believes that it may not be suitable for CVS to sell Oak Street Health or Signify Health because "they're currently achieving their targets."

In the second quarter, CVS reported a 27% year-over-year revenue growth, while Oak Street sales grew approximately 32%, indicating strong patient membership, according to CVS executives in an August earnings call.

Executives announced that Oak Street ended the quarter with 207 centers, which is a 30-center increase from the previous year.

What about keeping them since they are still strategic? Tanquilut stated to CNBC that it would be challenging to find a buyer for Oak Street due to the challenging market for primary care centers.

Improving the insurance unit

Addressing ongoing issues on the insurance side of the business is the "single best value-creating opportunity" for CVS if it doesn't undergo a breakup, according to Leerink Partners analyst Michael Cherny.

This year, the segment's performance has fallen short of expectations due to higher-than-expected medical costs, which is the biggest hit to the company's financial 2024 guidance and stock performance, according to Cherny. He is confident that the issue is fixable, but it will depend on whether CVS can execute the steps it has already outlined to improve margins in its insurance unit next year.

Aetna offers plans for the Affordable Care Act, Medicare Advantage, Medicaid, dental, and vision. The medical costs for Medicare Advantage patients have increased over the past year due to more seniors returning to hospitals for delayed procedures, such as hip and joint replacements.

Medicare Advantage, a privately run health insurance plan contracted by Medicare, has been a significant contributor to the growth and profits of the broader insurance industry. As of 2024, more than half of Medicare beneficiaries are enrolled in these plans, attracted by lower monthly premiums and additional benefits not covered by traditional Medicare, according to the health policy research organization KFF.

Medicare Advantage plans are causing rising costs that worry investors, as insurers predict that these costs may not decrease in the near future.

This year, CVS is facing a "double whammy" in Medicare Advantage due to both rapid membership growth and increased utilization of benefits by seniors.

In August, CVS announced that its revised full-year outlook was due to a decline in Medicare Advantage star ratings for the 2024 payment year.

Medicare health and drug plans are evaluated based on crucial ratings, which help patients compare their quality and determine the bonus payments received by insurers from the Centers for Medicare and Medicaid Services. Plans with four stars or more receive a 5% bonus and have their benchmark increased, providing a competitive advantage in their markets.

In a securities filing, CVS revealed that it could lose up to $1 billion in 2024 due to lower star ratings.

But things may start to look up in 2025.

In August, CVS executives stated that one of the company's large Medicare Advantage contracts regained its four-star rating, which will create an incremental tailwind in 2025.

Tanquilut stated that we are giving them the benefit of the doubt because we are confident that the stars rating bonus payments will return in 2025.

In May, CVS announced its intention to adopt a "margin over membership" strategy, with CFO Tom Cowhey stating that the company is prepared to lose up to 10% of its existing Medicare members in order to restore its margins.

In 2025, the company will make substantial alterations to its Medicare Advantage plans, including raising copays and premiums and reducing certain health benefits. This will result in the elimination of expenses associated with those benefits and the departure of patients who require or desire their use.

In August, CVS executives stated that the company would achieve a 100- to 200-basis-points margin improvement in its Medicare Advantage business through specific actions.