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Thursday, November 09, 2006

Analyzing CVS & Caremark Merger

By Yaser Anwar,CSC of Equity Investment Ideas

Investors of CVS have been concerned over Wal-Mart’s USD4 generics programme and potential changes in an industry pricing yardstick, Average Wholesale Price (AWP), seem overdone. I see CVS as a strong company that should benefit from the generic wave.

More recently, investing in CVS will need figuring out whether it makes financial sense for CVS and Caremark to create a far more vertically integrated structure than has been seen before on a very large scale.

CVS just reported EPS up & Caremark just reported earnings up 27%. As pharmaceutical distribution has become choppier, combining these two businesses makes sense.

CVS's guidance and take on the merger:

Increased competitive strength

Significant synergies from the combination
Accretion to earnings in the first full year
Solid cash flow generation opportunity
A platform from which to accelerate growth combined projected revenues for 06 are estimated to be approximately 75bn.
Operating synergies of approximately 400m and one time costs of $150m
With valuations below CVS’s 18x and Caremark’s 22x 1 yr. Fwd. multiples, the stock has potential to do quite well. I believe the market has greatly overestimated the impact on the CVS/Caremark business models from Wal-Mart/AWP changes.

The stellar 27% EPS growth from both ends of this new business shows that they are joining from a position of strength, not weakness.

Caremark expects to become cheaper and more appealing for customers. CVS expects to benefit from traffic from Caremark customers as well as participate in their superior growth of mail order and specialty pharma.

So investors shouldn't be so quick to write them out, yet.

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