Aetna (NYSE:AET) stock has soared of late, for two key reasons. First, a takeout of Aetna stock by CVS (NYSE:CVS) appears increasingly likely to pass regulatory muster. Secondly, CVS stock, a component of the consideration paid for AET stock, has gained, increasing the value of the offer.
And from here, it might be time to take profits in Aetna stock. But that doesn’t necessarily mean investors should forget about the story. CVS still looks like a buy, and Aetna stock offers CVS shares at a discount. But along the way, AET stock has one notable risk — even if it still represents an attractive way to get exposure to the merged company.
The Problem With AET Stock
The biggest issue with AET stock at the moment is that it’s essentially become an arbitrage play. CVS is offering $145 per share in cash along with 0.8378 CVS shares for each share of Aetna stock. At the moment, that package is worth $208.56; AET stock trades at $201.65.
That’s about a 3.5% discount — and perhaps closer to 4% if Aetna stock pays one more dividend before the deal closes. But that discount has narrowed sharply since the deal was announced back in December. CVS’s original deal valued the stock at roughly $207, yet AET traded at about $180.
And Aetna stock would tumble further through April, as the gap remained and CVS shares tumbled about 25% from late January lows.
What’s concerning here is that the discount prices in very little risk of the deal breaking. Particularly when considering the time value of money on the ~70% of the consideration being paid in cash (and potential tax implications), a 3.5% discount isn’t really that attractive for AET stock.
To be sure, the market does seem reasonably assured that the deal will go through. Last week, The Wall Street Journal reported approval from the Department of Justice was likely within a matter of weeks.
But the market has erred before. One only need to look at the drama surrounding the attempted merger between two of CVS’s rivals, Walgreens (NASDAQ:WBA) and Rite Aid (NYSE:RAD) for an example.
And if the deal breaks, AET stock likely would fall sharply. With the discount so narrow, AET stock itself seems best left to professional arbitrageurs.
Aetna Stock Is Valuable Because It Will Turn Into CVS
That said, I do think the combined CVS-Aetna will be attractive, and I like CVS stock even near a seven-month high. The tie-up makes some sense, allowing the combined company to capture more health care spend. As a Cowen analyst pointed out, it gives CVS some protection from the retail pressures facing Walgreens, Rite Aid and Fred’s (NASDAQ:FRED).
Meanwhile, CVS itself posted a nice Q2 earnings beat, and its own business seems to be headed in the right direction. The company is expanding its delivery program, an effort to stay ahead of Amazon.com (NASDAQ:AMZN) and its entry into the space.
And yet the stock trades at just 10x forward earnings. Debt is a concern, particularly given the large amount of cash paid for Aetna. But the company should be able to deleverage quickly, thanks to strong free cash flow.
If the Aetna deal breaks, CVS stock would take a much smaller hit than would Aetna stock. From here, then, the safer play is to own CVS stock.
Going through Aetna does give investors a discount, but there’s also risk involved. I can see why investors would want to own the combined company. But the safer way to do so is through CVS, not AET, even if that path likely will turn out to be a bit more expensive.
As of this writing, Vince Martin has no positions in any securities mentioned.
