This last weekend, CVS announced that they would be acquiring Aetna in a $69 billion deal. The deal looks something like this: every shareholder of Aetna stock will receive $145, plus 0.8378 shares of CVS stock, per share of Aetna stock they currently hold. There are broad financial and strategic implications for this acquisition – let’s take a look at some of the financial ones.
The first and easiest thing to look at is the change in the stock price (or more properly, the change in the market capitalization of each company). Since a company's market value is made up of the market value of equity plus the market value of debt, and since the market value of debt remains fixed (varying only with interest rates), any change in a company's fortunes should be immediately reflected in the market value of their equity, also called their market capitalization. Since their market capitalization is simply the current market price of a single share of their stock, multiplied by the number of shares outstanding, we often simply look at the price of stock to gauge the market's reaction.
On Friday, CVS's market capitalization was $76.10 billion; on Monday, it was $72.62 billion, a loss of $3.48 billion in value. That's not good for CVS. It could imply that the market believes they overpaid for this acquisition, or that the market believes that the acquisition itself may have negative synergies. To find out, we need to look at Aetna's market capitalization to see if this acquisition simply transferred wealth to their shareholders.
On Friday, Aetna's market capitalization was $59.13 billion. On Monday, it was $58.27 billion, a loss of $0.86 billion. Therefore, the market thinks this was bad for both CVS shareholders and Aetna shareholders. Far from being a transfer of wealth, this deal looks like it simply destroys value. The total destruction of value – $4.34 billion – was split between the two companies by the price paid. In this sense, CVS may have slightly overpaid for Aetna, but not by much. The bigger story is that the merger may simply be a poor strategic move.
There are other interesting wrinkles. For example, let's look exclusively at the price for a share of Aetna stock. It's been somewhat volatile since the sale (it jumped to $184 before dropping down to $179), but we can use a middle-ground price for this analysis of $180, roughly where it was before the announcement (unsurprising, given the small change in market capitalization). But wait – CVS is offering $145, plus 0.8378 shares of CVS (currently trading, after the announcement, at $71). $145, plus 0.8378 * $71 equals $204.48. CVS has promised Aetna shareholders $204.48 for their shares, but Aetna is only trading at $180. What's going on? Should we immediately run out and buy Aetna stock?
It seems there are two things occurring. The first likely has to do with discounting. The trade won't be completed until late next year, so the actual calculation should include the expected value of CVS at that time, discounted back to today. That $145 should also be discounted – if you sold your Aetna stock today (rather than waiting for the deal to close), you could invest that $145 and gain at least the market return. In other words, the market is taking next year's expected values of $145 plus 0.8378 shares of CVS stock, then discounting those values back to today, and finding a lower value than $204.48.
The other likely reason is the likelihood that the deal will be approved. Consider: it still needs to be approved by both CVS and Aetna shareholders, plus regulators. That means that the value of Aetna stock today should be the weighted average of the various scenarios – one in which the deal is approved, and one in which it is not. The lack of movement in Aetna's stock seems to suggest the market thinks the likelihood of approval by all three parties may be low. (To learn more about weighted averages, check out my analysis of Brexit.)
This is a very quick analysis of the deal, using only market reaction, but it demonstrates how stock price movements can be a valuable tool for assessing the market consensus. Thousands of traders and analysts looked at this deal on Monday, and it looks like they came to two big conclusions: the deal destroys value (in other words, it's unlikely to have been a good idea), and it is unlikely to be approved by shareholders and regulators.