Friday, October 03, 2008

The Longs And Shorts Of CVS Caremark

The Medicare Part D program is paying an interesting dividend for some the big pharmacy benefit management companies: they are now protected from short selling under new rules adopted by the Securties & Exchange Commission to combat the meltdown in the financial markets.

It turns out that CVS Caremark, Medco Health and Express Scripts qualify as “financial institutions” under those rules (at least as interpreted by the New York Stock Exchange) and so shorting the shares are prohibited until October 17, or longer if SEC extends the ban again.

Why? Because all three operate insurance divisions, primarily as part of the Medicare Part D stand-alone drug insurance offerings.

CVS, Medco and Express Scripts are not among the banks, big insurers and hedge funds initially protected by the SEC order. Oh yes, its true—one hedge fund was indeed protected from the short selling it practices…though it has since asked for those protections to be lifted.

But the SEC also set up a process for the stock exchanges to expand the list, and the big PBMs requested protection, citing their insurance divisions. So first Medco then CVS were added to the NYSE-protected list. (Express Scripts trades on NASDAQ and is protected via that exchange's procedures to implement the rule.)

Yep, that’s right. CVS turns out to be a fragile financial giant, right alongside Fannie Mae or the late lamented Lehman Brothers. As Reuters put it best, that notion certainly raised a lot of eyebrows among investors who are already critical of the notion that short-selling is somehow contributing to the financial crisis.

Nevertheless, the protection may give CVS a small added advantage in the context of a bidding war against Walgreen’s to purchase the West Coast retailer Longs Drugs. The deal, as we reported in “The Pink Sheet,” really focuses on the bricks-and-mortar pharmacy business in California. Walgreen’s is not on the protected list. (It does have a PBM division of its own, but it does not sponsor its own stand-alone insurance.)

Longs is also a relatively large Part D sponsor, through its Rx America division. The company, however, is also not on the protected list—though with a bidding war under way to acquire it, who would short it anyway?

So in the bidding for Longs, one party (CVS) has less to worry about when it comes to maintaining its own share price than the other (Walgreen’s). That’s not a decisive edge, certainly, but on the whole we’d rather be in CVS’ position. (In the unprecedentedly volatile market of the past week, it is simply impossible to determine whether the protections on CVS have made any difference versus Walgreens.)

In one sense it is only fair that CVS, Medco and Express Scripts are getting a little something back for jumping into Part D. As it happens, none of the big three PBMs was overly eager to dive into the new market—to them, it posed at least as much of a threat as an opportunity, since they have not historically been willing to be at-risk insurance companies, nor were they eager to see their lucrative retiree drug insurance products poached by new entrants in Part D. (You can read more about the mixed emotions of PBMs towards Part D here.)

On the other hand, the seeming absurdity of classifying CVS as a “financial” institution may further encourage a rethinking of the Part D model.

Both presidential candidates have big objections to the drug insurance program—albeit from radically different perspectives. But we’re betting that the current collapse of confidence on Wall Street—and in Wall Street—is going to give an even stronger hand to those who want Medicare managed more tightly by the federal government.

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