CVS & Caremark To Merge: To What End?

Wednesday's announcement of a proposed merger between CVS and Caremark leaves me puzzled. I believe it is being portrayed as a purchase of the latter by the former, but technically being proposed to be accounted for as a merger of equals.

The crux of my bewilderment over the combination is that they are such different businesses. In effect, almost ideally contrasting ones. Didn't Caremark, Express Scripts, and Medco arise to undercut the costs of prescriptions being dispensed through local pharmacy chains like CVS? If so, how does one now reconcile a combination a bricks and mortar drug store chain with a remote medicinal order fulfillment giant?

Doesn't this remind you of the ill-fated TimeWarner/AOL merger? Didn't that merger resemble this one, in the combination of two radically different business models, in which one (AOL) had more or less evolved to supplant the other?

From a somewhat self-centered management perspective, I see the attraction. Messrs. Ryan and Crawford see themselves running a company that accounts for more than 25% of the country's prescriptions. Somewhere in there, I am sure they have reasoned, is enough scale to fend off Wal-Mart. Both CVS and Caremark has seen their stock prices fall roughly 15% in the past three months, and even more since early September, when Wal-Mart announced its entry into the low-price prescription drug business.

My guess is, CVS saw itself being drawn into the maw of price-competition by Wal-Mart, and panicked. Caremark probably expects Wal-Mart to eventually start its own PBM business, damaging the former's margins and market share position. From inside the barrel of existing sector players, this combination of CVS and Caremark probably looked like a reasonable way of building a larger, hedged liferaft to weather the coming competitive storms.

However, for each company's shareholders, I can't see what it offers. If you hold CVS for the retail exposure, this is not a deal you want to see occur. Similarly, if you hold Caremark because you think it will eventually strip the CVS's of the world of their prescriptions business, this deal makes absolutely no sense whatsoever. Further, how do you explain the combination of two businesses whose mechanics and operating models are so different? What are the odds that anyone will be capable of successfully running the combined entity to earn consistently superior total returns for its shareholders?

Better that Caremark would have reached some sort of deal with Wal-mart, if that could make any sense. Or that offer to ally with Wal-mart and place CVS mini-stores inside Wal-Mart. Of course, this would be extremely unlikely, precisely because CVS is about more than drugs. It's about broader retail convenience shopping.

I just cannot see a savvy investor in either CVS or Caremark saying, "Gee, this is great! This deal plugs that hole in the company's distribution model."

I can, however, see Ryan and Crawford feeling that they each have a more secure next five years of CEO or Chairman's compensation for heading a somewhat incongruous conglomerate of two businesses which are totally at odds in their missions and business models.

This type of schizophrenic combination does not, in my opinion, bode well for the longer term ability of either company to consistently earn superior total returns for shareholders, as part of the new combined firm.