How to Capitalize on Health Care M&A

One of the most talked about trends in health care is the rising age of U.S. citizens, thanks to the vast number of baby boomers. Then there’s the fact that more people have health care insurance, thanks to Obamacare, which is also a  powerful trend that shouldn’t be overlooked.
But that’s not the topic of today’s discussion.
The trend, and one that’s most certainly your friend, in health care today is mergers and acquisitions. Health care M&A recently hit an all-time high. There’s been almost $396 billion in M&A activity so far this year, already breaking the full-year record set just last year.
Consider that for a minute: We’re just over halfway through the year and have already seen a record level of health care M&A.
With that, the Health Care Select Sector SPDR Fund (NYSEArca: XLV) is up more than 12% year-to-date, versus the S&P 500’s 2% return. And over the last five years, the return of the health care ETF is nearly double the broader market index.
One name that has been rather active in the acquisition market of late is CVS Health (NYSE: CVS). It bought up the pharmacy services provider Omnicare (NYSE: OCR) for nearly $13 billion. But one of its more interesting deals is the buying of Target’s (NYSE: TGT) pharmacy operations.

The Rite Stuff

Along those lines, what could be one of the best plays in the health care M&A market going forward is Rite Aid (NYSE: RAD). There’s the opportunity for Rite Aid to do a similar deal as CVS-Target, possibly with the nation’s largest grocery store operator, Kroger (NYSE: KR).
Although it would be a bit more aggressive, striking a deal with Wal-Mart (NYSE: WMT) could also be very advantageous. On the latter possibility, my colleague Jonathan Yates talked about why Wal-Mart should buy Rite Aid earlier this year.
Rite Aid could also be an enticing buyout target for Walgreens (NYSE: WBA), which has shown a knack for the retail space. It bought up Alliance Boots a number of years ago, which gave it a presence in the U.K. pharmacy and health-and-beauty markets.
Adding Rite Aid would be a quick way for Walgreens to boost its scale in the U.S., where it lacks a strong store presence in the Northeast – a place that Rite Aid has a stronghold.
Such a buyout could also mean store productivity gains at current Rite Aid stores. Rite Aid has a troubled history, with many of its stores underperforming CVS and Walgreens stores. However, by rebranding Rite Aid stores with the Walgreens name, there would be an immediate lift to brand value. Something similar happened with CVS when it bought Eckerd a decade ago.
Some months ago I profiled Walgreens as the only drugstore stock worth owning, but the shifting M&A environment is making both Walgreens and Rite Aid equally enticing. In particular, there’s the need for Walgreens to play catch up to CVS when it comes to M&A.
CVS continues to pull away in terms of creating a pharmacy behemoth, mainly driven by its presence in the pharmacy benefits management (PBM) space. Walgreens could really make a splash by buying up the nation’s largest PBM, Express Scripts (NASDAQ: ESRX).
In terms of Rite Aid, it recently made the foray into the PBM market by buying up Envision Pharmaceutical Services for $2 billion earlier this year. The key to this and many PBM deals is that it helps reduce drug purchasing costs for pharmacy operators.
Rite Aid could soon become the darling of the health care industry. With a market cap around $10 billion, it’s big enough to make large accretive deals – like buying up Kroger’s pharmacy operations – and yet small enough to be a relatively easy buy for a company looking to gain a larger presence in pharmacy retail.

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