Why CVS Health plans to split up pharmacy, Aetna and Caremark

CVS Health plans to break up, but this time the stakes seem more realistic.

The healthcare conglomerate on Wednesday announced plans to split into two publicly traded companies by the first half of 2028. CVS plans to separate its pharmacy business, which includes approximately 9,000 retail stores, from Caremark, a leading insurance business and pharmacy benefits management company.

The move comes more than two years after CVS considered disbanding but ultimately backed away from the idea. At the time, analysts questioned whether the retail pharmacy business could survive on its own.

“At the time, the idea of ​​a retail industry becoming independent was unthinkable,” Brian Tunkilt, senior equity research analyst at Jefferies, told CNBC.

However, the economics of business have changed. CVS’ retail pharmacy business has become more consistently profitable, while insurer Aetna has improved its performance despite continued high medical costs for its Medicare Advantage plans. Doing so could make it easier for companies to separate their divisions, and for investors to see the value of each division in isolation, rather than lumping them together into one vast healthcare conglomerate.

“To us, this is an indication of the stability of the pharmacy,” Michael Cherney, senior research analyst at Leerink Partners, said in an interview. “This business is very different from the business that was being considered three, five, 10 years ago, when there were continued headwinds that pharmacies couldn’t overcome.”

CVS CEO David Joyner told CNBC’s “Squawk on the Street” on Wednesday that in 2024, the company was “in a rebuilding phase” without the flexibility, capital or performance to carry out a separation. CVS has now exceeded Wall Street’s earnings expectations for eight consecutive quarters, thanks to improvements across PBMs, pharmacies and payers, and has raised its guidance multiple times over the past two years.

Since joining the company in 2024, Mr. Joyner has driven an aggressive turnaround plan that includes $2 billion in cost cuts, store closures, a leadership shakeup and Medicare Advantage cost containment.

The company also said it expects to generate at least $15.5 billion in operating cash flow in 2026, an increase of about 70% from $9.1 billion in 2024, and achieved its leverage goal ahead of schedule.

“What’s changed over the last two years is the fact that we can now look at this business and the assets that have been assembled and really decide without any pain or having to do anything what is the right strategic decision,” Joyner told analysts on a conference call Wednesday, adding that the decision was “by force.”

Investors have largely cheered CVS’ progress in recent years, but Wall Street appeared more pessimistic about Wednesday’s announcement as the company’s stock fell about 12%.

CVS’ retail business has benefited from changes in the competitive environment over the past several years, including widespread layoffs and store closures at Walgreens, Rite Aid and other pharmacy operators. This creates an opportunity for CVS to gain market share, some analysts told CNBC.

CVS also made changes to its pharmacy reimbursement model. The company’s CostVantage program is designed to replace traditional processes with a more transparent cost-based model. Some analysts say this has helped the company better align prescription dispensing costs and reimbursements, contributing to stable profits.

These developments represent meaningful changes for a company that has faced years of pressure from declining prescription reimbursements, store closures, and competition from online pharmacies and other retailers.

That doesn’t mean retail pharmacy has become a high-growth business. CVS’ retail pharmacy segment remains a relatively low-margin business, with adjusted operating margins of approximately 4% to 5%. But analysts say the company may now be stable and profitable enough to operate independently, even if investors value it at a discount compared to CVS’ other businesses.

Ben Hendricks, an analyst at RBC Capital Markets, said in a note Wednesday that the low valuations investors have assigned to the retail pharmacy segment are weighing on CVS’s overall value and obscuring the profitability of companies like Aetna and Caremark.

Tanquilt said the underlying growth in the insurance and PBM business was also stronger than the retail pharmacy growth, taking into account changes to Caremark’s rebate arrangements.

Specifically, Aetna has been able to better control healthcare costs by exiting unprofitable markets, expanding value-based care models, and tightening utilization controls.

The dissolution also comes as Caremark faces increased scrutiny of its PBM practices, including state-level regulatory challenges related to its relationships with businesses and pharmacies.

Republicans in Tennessee and Arkansas have passed laws that prohibit one company from owning both a pharmacy and a PBM. The Arkansas bill is believed to be blocked in court. Charney noted that legal hurdles for PBMs continue to mount in other states as well.

“I feel like we’re under even more pressure with this endless series of state lawsuits,” Charney said. “For lack of a better term, it’s unclear whether these two organizations have simply become too tenuous to combine as one and move forward. I don’t know.”

Still, Joyner told the Wall Street Journal that he is not splitting up the company over regulatory issues. CVS said the separation is based on a strategic review and aims to give each business greater focus and flexibility.

The move also marks a major departure from the integrated care strategy that CVS has spent years building.

CVS spent about $70 billion to acquire Aetna in 2018, arguing that combining health insurance, pharmacy benefit management, retail pharmacies and health care providers under one roof could help coordinate care and create a competitive advantage. CVS was still pushing that model as of last year’s investor day.

The proposed separation suggests that while the company is not abandoning vertical integration entirely, it believes there is more value in separating at least some of these businesses.

Aetna and Caremark will remain in the health care company, along with CVS specialty pharmacies, primary care clinic Oak Street Health, and Signify Health, which provides home visit services. This separate pharmacy company includes approximately 9,000 retail stores, a mail pharmacy operation, and MinuteClinic, a retail medical clinic located within certain CVS facilities.

Both sides are large enough to stand on their own, Cerny said. Caremark is one of the three largest PBMs in the United States, and CVS is one of the largest retail pharmacies in the United States.

However, separating the companies raises questions about how long the commercial relationship between the two companies can survive.

This relationship has historically benefited both parties. Currently, Caremark is able to leverage CVS’ extensive retail footprint to provide members convenient access to prescriptions and drive members to CVS stores through preferred pharmacy arrangements. For example, programs such as Maintenance Choice offer eligible members the option to prescribe certain maintenance medications at CVS retail pharmacies or by mail order.

These arrangements also helped drive prescription volume to CVS stores, giving the retail pharmacy division an important source of customers. Because the companies shared a parent company, the economic benefits of that relationship ultimately went to CVS as a whole.

In the memo, RBC’s Hendricks also questioned how the split could affect Aetna’s Medicare Advantage quality ratings, which determine whether a plan is eligible for bonus payments from the government. Retail pharmacists have played a role in engaging Aetna members, but diaspora could complicate that relationship.

But Joyner told analysts on Wednesday that the synergies between the two businesses “will be maintained in the commercial agreement between the two organizations,” adding that “no consolidation of operations is required.”

Joyner said CVS will work on these potential agreements over the next 15 to 18 months.

Preferred pharmacy networks are common across the industry, and separate ownership does not preclude Caremark from continuing to prioritize CVS pharmacies through negotiated arrangements, Charney said. The difference, he noted, is that under separate ownership, the profits from those arrangements no longer accrue to a single company.

“The question is not whether the two companies can continue to work together in some capacity, but whether future contractual arrangements will maintain the same competitive advantages and flexibility they currently have under joint ownership,” Charney said in a note Wednesday afternoon.

Still, both businesses face their own challenges.

Tankilut warned that some of CVS’ retail pharmacy gains in recent years have come as Walgreens and other competitors have closed stores, raising questions about whether it can sustain growth. The business also remains subject to consumer pressure and competition from online pharmacies.

Meanwhile, Caremark faces continued regulatory scrutiny and potential headwinds from changes to the federal government’s 340B drug discount program. The program requires drug companies to offer drugs at discounted prices to eligible hospitals and other health care providers who serve low-income and vulnerable patients.

CVS participates in the program by providing pharmacy services to these organizations, but tweaks to manufacturers’ data-sharing policies and possible reimbursement changes could put pressure on its business in 2027, Tankilt said.

Meanwhile, Aetna is working on a multi-year plan to rebuild its profit margins in an effort to improve the profitability of its Medicare Advantage business.

At the end of the day, CVS is betting that the value of having investors evaluate its businesses individually will outweigh the benefits of having them under one roof. This division tests whether each can thrive independently.