Paramount Eyes An Offer. Plus, What’s Ailing CVS?

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Pharmacy is touched in healthcare more than any other area. On average, the person picks up the prescription every 30 days. So when you look at that, they're in the pharmacy 12 times a year. You generally see your primary care doctor once, maybe twice a year.

Well, hello there, and welcome to the Barron Streetwise Podcast. I'm Jack Howe, and the voice you just heard, that's Lisa Gill. She's a healthcare analyst at JPMorgan, and she's talking about CVS. She's bullish. We'll also hear from someone who's not so bullish. CVS reports fourth quarter financial results soon, and I have questions. Not about the results. Why hasn't the stock done better over the past decade? What's ailing CVS and what are its prospects for better returns? We'll talk about it. But first, we'll say a few words about a buyout offer for Paramount. Listening in is our audio producer Jackson. Hi Jackson.

Are those new glasses?

Thank you for asking. They are not. You will— I had a little, I had a little oopsie daisy. I dropped my glasses about, I'm going to say a foot and a half to 2 feet off of the bedside table and they broke Right in the bridge, the middle part.

And did you step on the glasses? No, I didn't step on them.

I went and I asked at the glasses store, I said, what can be done? And they said, just abandon hope. There's nothing you could do. But my wife, it takes like 2 weeks to get a new pair. So all I have are drugstore readers and I can't see out of those things. So it's— look, people don't need to hear this story. My wife put some Gorilla Glue and then she wrapped some tape around it. So I have some— I have taped up glasses.

I'd say the bridge is looking pretty wide there. I thought it was a new style.

If anyone asks, these are Google Glasses with augmented reality. Anyhow. Okay, Paramount, that is the media company that owns CBS, a longtime leader in traditional television ratings, and the Paramount Plus streaming service, Showtime, another pay-TV service, and Pluto TV. That's a free ad-supported streaming service. What am I leaving out here? A lot of cable channels, Comedy Central, Comedy Central.. And then there's a bunch of international TV stations too. Oh, almost forgot Paramount, the studio business. They create a lot of content for film and television. Okay, so Paramount, you might recall, is the product of a combination between CBS and a company called Viacom. We have talked with Paramount CEO Bob Bakish on this podcast before. The company received a buyout offer this past week from Allen Media Group. It's a $14.3 billion offer. If you add in the debt, it works out to around $30 billion. And the stock market seems to be saying it's not going to happen. I say that because the offer works out to $21 and change for each non-voting share of Paramount. And the shares on Wednesday, that's the day of the offer, they went nowhere near the deal price. They were below $15 a share. They were up about 7% for the day. Why would investors think this offer is not going to work out? Well, for one thing, Byron Allen— that's the media entrepreneur behind Allen Media Group— he has a history of making offers that don't pan out. And for another thing, Paramount has a history of not being super duper receptive to offers. Byron Allen, for those who don't know him, is a billionaire and a one-time stand-up comic. When he was 18, he appeared on The Tonight Show with Johnny Carson. I'm still living with my parents, and in fact, that's why I want to talk about my parents tonight. How many people at one time in their life had parents? Another quick— Byron Allen did not make his riches in stand-up comedy. He started his own TV show. It was called Entertainers with Byron Allen, and he maintained ownership of the show. And then he called around to television stations to try to get them to syndicate the show. That was a lot of work. In an interview he says he called 1300 TV stations. He says he probably got about 50,000 noes to get around 150 yeses. That is a lot more no's than it is. It's a shockingly high ratio of no's to networks is what I'm thinking.

What if it was just one guy who said no, no, no, no, no, no, no, no.

Just over and over after 15 minutes you're like a thousand no's closer to it. Yes, you just stick with it. Eventually made good money from his interview show, sold a lot of commercial time, and his success there led to the purchase of the Weather Channel. And he was off and running acquiring media properties. Byron Allen tried to do a deal in the past with Paramount. He tried to buy BET and VH1 for a combined $3.5 billion. He also tried to buy ABC and other networks from Disney, and he once explored a bid for the Washington Commanders. That's the pro football team. Okay, so why wouldn't a company trading at under $15 a share think that $21.53 a share for its non-voting shares is a good deal? All I can tell you is that just a few years ago, there were people on Wall Street who said the company was worth a lot more. B of A Securities 3 years ago did a sum of the parts analysis and said that Paramount was worth $53 a share, but that value has been slipping. By early last year, BofA said $32 a share, and last November it said the price would probably be 30% lower than that if it didn't update some of the parts analysis. But instead, it slashed its rating on the stock and its price target all the way down to $9. Why is that? Well, it's partly based on the belief that Paramount has been overly resistant to a sale in whole or part, and that without one, the company's value will continue to slide. The stock has not been a great performer, or even a good one, or an okay one. Paramount shareholders have lost 66% over the past 3 years. S&P 500 investors have made 39% over that time. This past week, BofA revisited its case, and it's sticking with $9. It says that this latest offer raises more questions than answers about things like possible deal timing and potential asset sales and how the company is going to manage its debt. So how did Paramount's value erode so quickly over the past 3 years? Well, a few things have changed for the company and for its peers. First, cable customers are leaving faster than expected. Subscriptions are declining at double-digit percentages, and the rate seems to be accelerating. Second, growth in streaming subscriptions— that has broadly fallen short of investor hopes. And third, the idea of burning cash to fund content for streaming— that has fallen out of favor with investors. So companies are turning to layoffs and other cost cuts to boost their cash flow. Now, one exception out there is Netflix, which recently reported blowout subscriber gains. It's generating a growing stream of free cash. Essentially, the script for streaming has flipped. Legacy TV companies used to be reliable cash generators, and now many are iffy ones. Paramount, which has considerable debt relative to its current earnings power, is expected to produce negligible free cash flow this year after 2 years of burning cash. But Netflix, it was once a big cash burner. Now it's starting to look like a show business Death Star. It's capable of outspending even Walt Disney on streaming content.

It's also growing globally really fast. So US added 2.8 million households, but 5 million in Europe and 2.3 million in Latin America, 2.9 in Asia.

It's a good point because one of the long-term bullish cases for streaming is that unlike traditional television where you make shows and you distribute them in a particular region, for streaming you can distribute shows worldwide.

Imagine WWE translates pretty well.

Does it overseas? That's right. Netflix has a deal. It's a, it's a good deal. Well, we'll talk about this another time, but they have a deal to, to show TV wrestling basically on Netflix. Everyone's doing these sports deals because we've talked about how attractive sports are. Great ratings, audiences skew young, they watch live, it's good for ad sales. But the prices for sports rights are sky high. So I think this WWE is a way to sort of get your foot in the door with live events and wait to see whether prices for other sports fall fall over time. It also comes with a lot of optionality because after— it's a 10-year deal, but after 5 years Netflix can back out or it can extend for another 10. Have you ever been a TV wrestling fan, Jackson?

No, but now it's on Netflix, I might take a look.

I was a rabid fan when I want to say about maybe, I don't know, maybe 9 years old or something like that, back in the Andre the Giant days. It was— oh, I only had 2 questions back then, and one was, is pro wrestling real? And the other was, how do I become a ninja? So it was right. It was right in my wheelhouse back then.

Where was I? Uh, Netflix Death Star, right?

So that's kind of why B of A is skeptical/bearish. They're saying they don't really know how quickly a deal could get done, but the longer it takes to do one, the bigger the risk that the business continues to erode. They think there has to be more consolidation in streaming They do call Paramount an attractive takeover target. So we'll see what becomes of the Allen offer. And that is Paramount. Jackson, do we blast straight ahead to CBS and start hearing from our analysts, or do we take a break here? What would a young Byron Allen do? He seems to have known a thing or two about where to stick commercials.

You'd want to hear from the sponsors.

We'll be back after this quick and probably illuminating break. Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks. At CLA, we're in your corner and on it. We coach tax strategies and Little League first base. We help you adopt AI data data tools, and we adopt rescues named Buddy. We walk your factory floor and jog the local 5K, though sometimes we walk that too. Wherever you're coming from, we're right there with you. Wherever you're going, we'll get you there. CLA—CPAs, consultants, and advisors. Learn more at claconnect.com/withyou. Welcome back, Jackson. You're a young and fit guy. You probably don't go to the doctor too much or have too many ailments. So I'm guessing you have not been to a Minute Clinic at the CVS.

Have you been? I've gotten a vaccination in the tampon aisle.

First of all, there's not a whole aisle. First of all, it's not— there's about 8 aisles at the store, so they don't have a whole aisle just for that. It's part— maybe you were in that section.

I mean, it was waiting. Yeah, I think it was in the section. All right.

Well, that's an added detail that no one was really looking for. But I take your point that I have also been there only for vaccinations, um, and it feels a little weird. I mean, it's good in that it's convenient to make the appointment. You can make it right in your phone. It's usually pretty quick. You go over, and I signed up for 3 vaccinations. There were 2 that were regular seasonal things, and there— then there's one that— I'm a half century old, so there's this thing called the shingles. When you, when you reach a half century, there are, you know, old-timey, uh, ailments like this that you become susceptible to, they tell you you should get a vaccination. Shingles. So I was supposed to get one of those. I signed up for all 3 on the thing and I went over and like you say, it feels a little bit like, I don't know, you're— here's some Oreo cookies over on one side, here's some Bic pens over on the other, and you're getting shots. It feels a little out of place. Now, I don't know that this was the full, uh, health hub experience as CVS used to call it, and there was a problem because they were out of one of the vaccines. And then the guy told me, don't get that many vaccines at the same time because your arm will hurt. Like, the app didn't tell me that, but the guy told me that. So I took his advice. Anyhow, I mentioned this just to say that we have spoken with CVS in the past. It's been a little while, but we spoke with the former CEO on this podcast early in the pandemic. His name was Larry Merlo. And we had talked over the years about CVS's vision of the retailization of healthcare. It wanted to become this destination where people would go for their basic healthcare needs and they would make use of nurse practitioners and other individuals who can write prescriptions. And there would be this expanding menu of services and it would be good business for CVS. And it's a business that would also play nicely with its Aetna health plans and its pharmacy counter and its, its PBM or pharmacy benefits manager called Caremark. And I just don't sense that that idea has taken off by now. I would have thought that you could get a kidney stone removed in aisle 3. That's not happening as far as I know. At one point I flew out to Houston for the sole purpose of visiting one of these new health hubs that CVS was, was trying out to see, you know, the future of this retail health care business. I don't see a lot of that type of setup now where I live in New York.

How did it look different from a regular CVS?

What was it? Had sort of a concierge in the middle of the store to direct you where to go, and then it had a bunch of rooms on the sides of the store for people, I guess patient rooms. I wouldn't say even that looked like a doctor's office. It definitely looked like a store. But the reason this is on my mind now is that CVS reports fourth quarter results this coming Wednesday. And it just occurs to me that I don't detect a lot of anticipation around the results. I don't, I don't sense that people are sort of on the edge of their seats wondering about where the numbers are going to come in. I mean, the forecast is that earnings are going to be down just a little bit. For the quarter and for the year. Really, earnings are very little changed from 2 years ago. Wall Street is predicting a modest decline again this year. And if you look at the stock, it has sharply underperformed the U.S. market over the past 1, 3, 5, and 10 years. So those things tell me whatever was supposed to work when I last checked in with the company does not seem to be working. And the company is under new management now. And so I wanted to check in with a couple of Wall Street analysts to hear maybe what has gone wrong and whether the right pieces are in place for things to go better from here. So I thought I would start with hearing from a CVS bear, only there are no real bears there. There are no— if you look at the analysts that are tracked by FactSet, I don't show any sell ratings, just hold ratings. So I checked in with an analyst with one of those hold ratings. His name is George Hill at Deutsche Bank, and he downgraded shares to hold from buy back in March 2022. They were around $108 back then, and they've since slid to $74-ish. George says that retail pharmacy is a bad business, which doesn't sound great if you're a big drugstore chain. Here's George.

Like, the retail pharmacy business is a structurally challenged business. I, I would characterize it's a bad business, as is evidenced by Rite Aid going bankrupt. You can look at Walgreens stock price, which is an indicator reimbursement in the back of the store, revenue margin all going the wrong direction. And that has weighed on the stock price as well.

Could I just ask you to drill down on that point for a moment? Because I think there will be people who hear this who say, well, boy, I still pay a lot for my medicine. Isn't there enough money to be made there? How is it that these, you know, retail pharmacy operations are not making money? What is deteriorating there?

What people misunderstand about pharmacy is about 90% of prescriptions are paid for by one of 3 companies. It's either— the funny thing is, it's either CVS's own PBM Caremark, Cigna's Express Scripts, or United's OptumRx business. I get to use one of my fancy economic words, which is oligopoly, which is there are basically 3 payers that exist in this market. But the problem is, is that the PBMs are trying to deliver lower costs to their customers. Such that they squeeze the retail pharmacies. I mean, if you think about a retail pharmacy as a business, there's probably 25% of them too many in the country. So there's excess capacity. There's— they're what I would call a very lightly differentiated business, if differentiated at all. I would ask most consumers, do you care if you walk into a CVS, a Walgreens, or a Rite Aid? The answer is probably not.

You heard George use the word Oligopsyny. Jackson, I know that you're thinking, did he mean oligopoly? Admit it. Admit it to the audience right now.

That did cross my mind.

Thank you for your candor. An oligopoly— and I'm going to read from the dictionary here— it's a state of limited competition in which a market is shared by a small number of producers or sellers. An oligopsyny is the same kind of thing, except there are a small number of buyers. A PBM is really a buyer. They act on behalf of the people who are ultimately paying for the drugs, and they go and they buy the drugs from the drug retailer. One of the things that's so striking about CVS is it is a big drug buyer through its PBM. It is also a big drug seller through its pharmacy business. You would think if you have a dominant position in both buying and selling, you could find some way to turn that into favorable economics for yourself. But the poor stock returns that I cited a short while ago tell you they haven't really done that. And you can take a look at UnitedHealth Group. That's another healthcare mashup. It owns a big PBM and it owns a big health plan. It doesn't have the drugstore chain. That stock has returned 719% over the past decade. That's triple the S&P 500's return. And again, the big difference in the pieces here is that CVS has the drugstore chain. It seems like it's not helping. And George says that the PBM business, even though there are only a few dominant ones, it's competitive enough where Caremark, which is CVS's PBM, can't really go and be overly generous with CVS's pharmacy business or it might lose PBM customers. So how do you fix this? Well, CVS is pushing into some higher value healthcare services, which we'll come to in a moment. But one thing that could help is fewer drugstores. Here's George.

They're shutting down about 10% of their stores, so they're trying to fix the capacity issue. So is Walgreens also shutting down a big pile of stores. Rite Aid is probably going to wind up closing a bunch of stores through its bankruptcy process. So you will see some of this capacity come out of the system and the elimination of those stores could start to stabilize the capacity issue, which we would hope would stabilize pricing. But there's still 60,000 something pharmacies in the country. Again, there's probably 20,000 more than we need. I'm in New York City today. I know I can't walk 2 blocks without walking into a Duane Reade, a Walgreens, and a CVS.

It goes, it goes drugstore, bank branch, fake European, you know, cafe, and then drug, and then starts over again.

Insert nail salon.

Right. Thank you, George. Jackson, you think it's fair what George says about there being little differentiation between a CVS, a Rite Aid, and a Walgreens? What do you If I name them one by one, how about you tell me the first image, the very first thing that comes to your mind quickly. Ready?

CVS. Expensive mouthwash.

So specific. Rite Aid.

Well, there's, there's one that had ice cream in it near my grandma's house. Okay. I don't see that at CVS.

Writing that down in my reporting notebook here. And Walgreens.

I was going to say you can print photos, but I just printed photos at CVS. CVS is the long receipts, so maybe Walgreens is normal-sized receipts.

I think we've, I think we've made George's point abundantly clear. And George points out that, you know, the stock— I asked him like, what would you have to see to get interested in the stock? Because CVS stock goes for about 9 times earnings and the broad US stock market is about 20 times earnings. So you could make a case that the stock is cheap. He says the problem is with the P/E ratio, it's the E, the earnings. He thinks that those earnings are going to continue to slip, uh, this year, possibly next year. So he wants to wait and see some stability there, uh, before he calls the stock attractively priced. Okay, so what about the bull case on CVS? For that, I spoke with Lisa Gill, who covers the company for JPMorgan. Lisa points to new management, a new strategy, and a couple of recent acquisitions.

So Karen Lynch, who was the president of the Aetna business and came from the Aetna transaction, became CEO in the spring of 2020. And what she brought to the table was this strategy around really being a healthcare destination. So focusing on the growth of Medicare Advantage, and building out services around Medicare Advantage. So if you look at during 2023, right, so the fall of '22 and the early parts of '23, they made two acquisitions. One, Signify, and the second acquisition that they made was Oak Street Health. And those two businesses really help to fortify the focus that they have around the senior population and managing that senior population in a Medicare Advantage program.

Oak Street Health is a primary care provider with a focus on seniors. Signify provides home health assessments. That's useful in this new push toward what's called value-based care, away from paying fees for each individual service and towards hitting health benchmarks. And for that, you need to know about people's starting level of health. And those home assessments are useful there. If you think about the two CEOs and where they came from, the former CEO was a pharmacist originally. And his vision of healthcare was something that could be delivered in the stores. But that makes you think about what I'll call lower-value health services like those vaccine shots. Important? Yes. Lucrative? I don't think so. The new businesses get CVS involved in more higher-value healthcare services. Lisa likes that CVS is closing underperforming stores. She points out that retail pharmacy is less than a third of operating profit, but As you heard at the very beginning of this episode, she still sees those drug counters as being an important asset for the company. She says CVS's pharmacy benefits manager, Caremark, is a steady earner. We talked a little bit about PBMs. Sometimes they're described as middlemen in the drug business, and there's disagreement on whether they do or don't ultimately get savings for individual patients. Lisa says they do get savings, but it's not always easy to see.

And so the PBM, yes, it's profitable. Yes, you look at the cost savings that they're able to generate. So why are we as individuals not really feeling it at the retail counter? And why is there so much focus on the PBM around this? The reason is, is that well over 50% of health plans today are what are called high deductible, meaning that the average deductible, the average out-of-pocket cost is well over $2,000 a year. Year. You have to meet that even within pharmacy. So you're paying the list price of the drug. The discounts that the PBM is able to negotiate go to your employer, and the employer will say, well, you know what, I use that to keep overall premiums down. I use that for a smoking cessation program. I use that, you know, for gym memberships for my employees. So they are benefiting in some way., but they're not benefiting at the pharmacy counter. What needs to happen is for high deductible health plans to be able to separate pharmacy versus medical so that the patient can truly benefit.

That brings us to what's going to go right for the stock from here. If you are cautious on the stock like George, nothing just yet. If you're bullish like Lisa, what's the catalyst that's going to improve returns? Here's Lisa.

I think what improves the returns on CVS is two things. One, absolutely them meeting or exceeding expectations when you think about the numbers. And then secondly, really understanding what their strategy is. I think part of what's holding CVS back is their current multiple. So if you look at other managed care companies, they're trading on average in the 14 to 15 times range and the elite name being UnitedHealthcare trades at 18, a little more than 18 times earnings. So, you know, when CBS is trading at, you know, less than 10 times earnings, that's telling you that one of two things, either people don't believe their numbers or they don't believe their strategy. And so, you know, I think they finally have the pieces in place that they've wanted to put in place. And now it's a matter of executing on that.

Thank you, Lisa and George, and thank all of you for listening. If you have a question that you'd like answered on the podcast, let's hear it. And I do mean hear. Just tape it on the voice memo app on your phone and you can send it to jack.how@barons.com. We accept doozies, zingers, stumpers, gotchas. Please no whammies. Jackson Cantrell is our producer.

Jackson, anything to add? Knock knock jokes are also welcome. I also want to add that only half of people who listen to this show follow it. So we can get those numbers up so you can get a notification in your app when a new episode comes out.

We're going to end by shaming people.

I mean, you know, hey, you should be part of the half that's just—

I was just patting everyone on the back. You know, thanks for listening. We want to hear from you. All right, look, what Jackson says too. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. And if you listen on Apple, you can write us a review. That's it. Thanks. We'll see you next week. Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.