CVS/TGT: What Does the Store-In-Store Strategy Mean for RAD?

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Richard Evans / Scott Hinds / Ryan Baum


203.901.1631 /.1632 / .1627 richard@ / hinds@ /


June 23, 2015

CVS/TGT: What Does the Store-In-Store Strategy Mean for RAD?

  • If we assume CVS cannot repeat the TGT store-in-store deal with other major mass merchants, but can do such a deal with a single supermarket (who would likely impose limits on further deals with other supermarkets), its next best option is a store-in-store deal with KR. A CVS/KR deal would increase by 5.9% the share of the US population living in areas in which CVS cannot be excluded from pharmacy networks
  • If we assume WBA can complete deals with one major mass merchant and one major supermarket, its best options are WMT and KR. WMT would increase WBA’s ‘cannot-be-excluded’ percentage by 7.6%, and KR increases the percentage by 5.0%, for a total theoretical gain of 12.6%
  • If we assume WMT will not give up control of its pharmacies (we don’t think they should) and that KR is unavailable to WBA (perhaps having gone to CVS), WBA’s best store-in-store strategy would be SWY plus Kmart, for a combined 4.7% gain in the share of the population living in areas where WBA cannot be excluded from retail pharmacy networks
  • By way of comparison, a RAD acquisition would increase CVS’s ‘cannot-be-excluded’ percentage by 8.5%, and WBA’s by 9.7%. Acquiring RAD is a better option than any single store-in-store deal, and if WMT keeps control if its pharmacies, RAD is a better option than any feasible combination of store-in-store deals
  • In theory, the store-in-store strategy has the advantage (relative to a RAD acquisition) of eliminating outlets that likely would have been used as loss leaders to drive front store traffic by their supermarket and/or mass merchant operators. In truth, we doubt WBA and CVS can soak up enough of these outlets to have an effect

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. VRTX, BMY, SNY, ROCHE); Biopharma companies with pending major product approvals (e.g. ALIOF, ALKS, AMGN, BDSI, ENDP, HLUYY, HSP, ICPT, JAZZ, NVS, PTCT, RLYP, RPRX, TSRO, UCBJY, VRTX); ABBV and ENTA on sales prospects in Hep C; SNY on undervalued basal insulin franchise and sales potential for Praluent (alirocumab), in addition to its undervalued pipeline; AZN and LLY on the likelihood that excess SG&A/R&D spending must be reined in, in addition to pending major product approvals; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen; RAD as an acquisition target as WBA and CVS seek to defend against narrowing retail networks

Where we’re BEARISH: Biopharma companies with overvalued pipelines (e.g. GILD, ALXN, SHPG, REGN, CELG, NVO, BIIB); PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX, CTRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS, RAD); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

We’ve been arguing for some time that US retail pharmacy networks will narrow[1],[2], and that pharmacy chains would do well to maximize their local market shares as a counterweight to narrowing networks. Because RAD offers the greatest potential gains in local market shares, and because we believe bringing less efficient RAD outlets under a WBA or CVS umbrella increases their efficiency (largely through better procurement), we believe that RAD can be acquired accretively despite its recent outperformance[3],[4]

We appreciate that CVS’s acquisition of TGT’s pharmacy outlets challenges our notion of RAD’s strategic utility. Because CVS appears to have purchased only the operations ‘behind’ the pharmacy counter – i.e. excluding what would classically be considered pharmacy ‘front store’, the acquisition cost per retail pharmacy outlet gained is efficient — about $1.1M per TGT outlet, as compared to roughly $4M per RAD outlet. However, the requirement to rent space for the TGT outlets raises the true economic cost per outlet. And if we consider that an RAD acquisition transfers ownership of real estate, brings in ‘front store’ turnover, and offers considerable opportunities for store-level operating synergies, we can imagine that a RAD acquisition is on par with, or perhaps even better than, the TGT deal in broad economic terms. Nevertheless in more narrow strategic terms, if maximizing the number of pharmacy counters you control in a given geographic area is your immediate priority (and it should be), the dollar-per-outlet efficiency of the store-in-store strategy is impossible to deny. Adding to the attractiveness of the store-in-store strategy is the fact that this strategy eliminates a number of the local outlets that would have been most likely to lower their dispensing mark-ups

So where does this leave RAD? Thinking in terms of potential share gains, RAD is still superior to any single store-in-store deal; and if we assume WMT maintains control of its pharmacies, RAD is superior to any feasible combination of store-in-store deals. We believe the most useful market share metric in this context is the percent of the US population that lives in a geographic area where a given NEWCO cannot be excluded from a pharmacy network that complies with common proximity criteria[5]. Exhibit 1 compares the impact of RAD on this metric to the impact of any major store-in-store deal, for either WBA or CVS (the CVS figures in Exhibit 1 already include the TGT outlets). For WBA, a RAD acquisition increases the percentage of Americans who live in an area where WBA must be included in a compliant retail network by 9.7% (read from the far right column, which is net of probable outlet divestitures); this compares to WBA’s next best option, which is a store-in-store deal with WMT increasing the same percentage by 7.6%. For CVS, a RAD acquisition would increase the percentage by 8.5%, as compared to a (highly theoretical) WMT store-in-store deal that would raise the percentage by 9.5%. More realistically, since we know that the terms of the CVS/TGT deal preclude CVS from doing similar deals with certain TGT competitors, we assume CVS isn’t free to do a WMT deal, in which case a store-in-store deal with KR is CVS’s next best option, which raises their percentage by just 5.9% – much less than RAD

For several reasons, we doubt the majority of pharmacy outlets currently owned and operated by supermarkets or mass merchants can be converted to store-in-store formats operated by WBA or CVS (or RAD). First and foremost is that we’re reluctant to believe TGT’s motives for its alliance with CVS are shared by its mass merchant peers. We accept that CVS can procure generics (but not brands) more cheaply than supermarkets and mass merchants – but the logic around relative operating capabilities ends there. Setting aside procurement we don’t agree that CVS is able to operate a pharmacy outlet – or an in-store clinic – with substantially greater efficiency than a relatively large supermarket or mass merchant chain

We further doubt that a majority of supermarkets and mass merchants would be willing to cede control of in-store pharmacies just as the option of using them to drive front-store traffic is materializing. The major retail chains take between 63% and 69% of total store sales from the pharmacy counter; by comparison supermarkets and mass merchants take between 6% and 10% of sales from the pharmacy counter. Before retail networks began to narrow, supermarkets and mass merchants could not drive front store traffic by agreeing to dispense prescriptions for less – since most insured Americans were (and for the time being still are) in drug benefit plans that offer them no price advantage for using one pharmacy instead of another. However as networks narrow (or at least ‘tier’), consumers are essentially paid to go to pharmacies that dispense for less – meaning supermarkets and mass merchants are increasingly able to get shoppers in the store (to drive the 90% – 94% of sales that occur outside of pharmacy) by agreeing to lower dispensing fees

Finally, even if most supermarkets and mass merchants wanted a CVS/TGT-type deal, we expect most would also insist on the same restrictions TGT applied to CVS with respect to repeating the deal with competitors. This implies that CVS may be unable to do a similar deal with a mass merchant, but could still be able to do a comparable deal with a supermarket – its best option here being KR. Similarly, this implies WBA’s optimal store-in-store strategy might be deals with the largest ‘available’ supermarket (KR) and mass merchant (WMT). In aggregate if both CVS and WBA pursue optimal store-in-store strategies (thus tying up WMT, KR, and SWY outlets), then the total share of outlets controlled by supermarkets and mass merchants would fall by about 14.6%[6]. If we assume WMT won’t give up control of its pharmacies, then the optimal strategy becomes Kmart, KR, and SWY – in which case the total share of outlets controlled by supermarkets and mass merchants would fall by only 7.4%


  • The store-in-store strategy is less expensive than a RAD acquisition in terms of the number of outlets controlled per dollar spent. However …
  • CVS and WBA almost certainly cannot minimize the share of pharmacy outlets controlled by supermarkets and mass merchants, thus these pharmacies are likely to survive, and in some cases are likely to be operated as loss-leaders in the interest of driving front-store traffic. This limits the strategic impact, specifically as it relates to competitive pricing pressures, of controlling supermarket and mass merchant outlets
  • In terms of raising the percentage of persons living in an area from which the NEWCO’s pharmacies cannot be excluded from networks, RAD offers the largest available gains (9.7% to WBA, 8.5% to CVS)
  • As compared to acquiring RAD, CVS next best option is to raise the percent of the population living in areas from which it cannot be excluded by entering a store-in-store deal with KR (5.9% gain). Assuming TGT has barred CVS from other mass merchant deals, and that KR would bar CVS from other supermarket deals, KR would be CVS’ last store-in-store option
  • As compared to acquiring RAD, WBA’s next best option is to enter the best available supermarket (KR) and mass merchant (WMT) deals, raising the share of the population living in areas from which WBA cannot be excluded by 12.6%. More realistically, if WMT refuses a store-in-store strategy, WBA’s next best option is a pair of deals with KR and Kmart, raising the share of the population living in areas where WBA cannot be excluded by 6.8%. Finally, if we assume KR is unavailable, the best store-in-store strategy becomes SWY plus Kmart (making the cannot-be-excluded percentage 4.7%)
  1. “WAG/RAD: Pressure on generic dispensing margins likely to be much more permanent than guidance implies”, SSR Health LLC, October 14, 2014
  2. “WBA/CVS/RAD: There are simply too many pharmacies, and now it starts to matter”, SSR Health LLC, February 25, 2015
  3. “CVS/MCK/RAD/WBA: How WBA or CVS can fight narrowing retail networks – buy RAD”, SSR Health LLC, April 6, 2015
  4. “A WBA/RAD or CVS/RAD NEWCO as a counterweight to narrowing retail pharmacy networks”, SSR Health LLC, May 4, 2015
  5. Specifically the CMS/TriCare standard that requires 90% of beneficiaries live within 2,5, or 15 miles of an in-network pharmacy in urban, suburban, and rural settings, respectively
  6. WMT’s national share of outlets = 8.6%, KR = 3.9%, SWY = 2.1%
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