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CVS Goes Shopping: Financing the Target Purchase

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Recent acquisitions

CVS Health (CVS) has been aggressively expanding, announcing its intention to acquire long-term care provider Omnicare (OCR) in May 2015 for $12.7 billion in an all-cash deal. CVS also acquired Florida-based Navarro Discount Pharmacy last year for an undisclosed sum.

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Financing decisions

As mentioned in the last article, CVS Health (CVS) plans to use debt financing to pay for its $1.9 billion purchase of Target’s pharmacies and clinics. The company also noted that it is targeting an adjusted debt to EBITDA[1. Earnings before interest, taxes, depreciation, and amortization] ratio of 2.7x.

CVS estimates that the Target purchase, along with the Omnicare (OCR) deal, will raise its adjusted debt-to-EBITDA ratio to 3.2x. The company plans to pare this down to its stated target of 2.7x via higher earnings and gradually paying down debt.

However, we think this could hamper CVS’ ability to raise further debt for future acquisitions without compromising its stated debt coverage targets in the short term. Currently, the Target and Omnicare deals are subject to regulatory approval.

Peer group activity

Competitors have been active acquirers as well. In December 2014, Walgreens Boots Alliance (WBA) closed its acquisition of Alliance Boots. Boots is Britain’s largest pharmacy chain.

In February 2015, CVS competitor Rite Aid (RAD) announced its $2 billion purchase of Envision Pharmaceutical Services. The transaction will allow Rite Aid to compete in the Pharmacy Benefit Manager space, joining Walgreens Boots Alliance and CVS.

Diplomat Pharmacy (DPLO) announced two purchases this year:

  • In April, DPLO announced it was acquiring BioRx LLC, a pharmacy and infusion services provider in a cash and stock deal.
  • In June, DPLO announced the acquisition of Burmans Specialty Pharmacy in a cash and stock deal

In July 2014, DPLO acquired specialty pharmacy chain MedPro. It also acquired pharmacy services provider American Homecare Federation in January 2014. The terms of both deals were undisclosed.

Debt profile

CVS had short-term and long-term debt totaling ~$17.8 billion as of its last quarter ending March 31, 2015. The OMR and TGT deals will take that to over $26 billion by the end of 2015, assuming the transactions close by then and factoring in scheduled debt repayments.

The company has a long-term Standard & Poor’s credit rating of BBB+ and a Moody’s rating of Baa1. While that is still investment-grade, the higher assumption of debt along with its implications for financing costs may limit CVS’ ability to acquire new companies over the short term to medium term.

CVS, WAG, and RAD are among the top ten holdings in the First Trust Consumer Staples AlphaDEX Fund (FXG). FXG has 24.7% of its holdings invested in food and staples retailers.

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