Caremark Investors Shouldn’t Get Too Excited About Sweetened CVS Bid

Shares of Caremark (CMX), a leading pharmacy benefits manager, are jumping today after the company received a sweetened takeover bid from drug store chain CVS Corp (CVS). Caremark has already agreed to a merger of equals with CVS in a stock deal worth 1.67 CVS shares, but arch rival Express Scripts (ESRX) has entered the mix by making a hostile cash and stock bid that is worth about $4 more per share (~$57 versus ~$53).

Worried that Caremark shareholders would vote against the agreed upon deal in its present form, CVS announced yesterday that it would pay a $2 special dividend after the deal closes. The financial press is reporting how this dividend closes the gap between the two outstanding offers (the ESRX offer worth about $57 is now only about $2 higher than the sweetened offer). However, it is correct to assume that this $2 special dividend really equates to a $2 increase in the CVS offer?

Let’s recall what happens when special dividends are issued. The stock price reflects the payout (which is a reduction of net asset value to the paying firm) and the stock trades lower by the amount of the dividend. This prevents arbitrage investors from buying company shares right before the record date and earning a $2 profit when the dividend is issued several weeks later. When cash is transferred from the corporation to the shareholder in the form of cash, the company’s shares are worth less and market forces reflect that.

Think back to the much talked about $3 special dividend Microsoft (MSFT) paid out in November 2004. Microsoft stock dropped from ~$30 to ~$27 after the payout. Investors do benefit by being able to cash out some of their position (assuming they don’t reinvest the dividend), but the shares aren’t worth any more by paying a dividend because the stock price reflects the payout right away by trading down in price afterwards. In fact, investors face a taxable event when special dividends are paid out, whereas they wouldn’t have if the money was kept in the company’s bank account.

If you own Caremark shares and are thinking about this CVS merger and how you would vote, consider that the newly added $2 special dividend really doesn’t cut the gap between the CVS and ESRX offer in half. It merely gives you some cash to go along with the 1.67 CVS shares you would receive in exchange for each Caremark share you own.

Full Disclosure: No position