(This article was originally published Wednesday.)

By James Covert

Of DOW JONES NEWSWIRES

NEW YORK -(Dow Jones)- The merger of CVS Corp. (CVS) and Caremark Rx (CMX) will forge an alliance between two segments of the industry that have been battling each other for patients, creating a giant drug distributor with increased buying power and dominant retail and mail-order positions.

The Woonsocket, R.I., drugstore chain and the Nashville-based pharmacy- benefits manager said Wednesday they have agreed to combine in an all-stock deal worth about $20.7 billion based on the price of CVS shares at Wednesday's close.

CVS is purchasing a key player in a rival channel in the drug-distribution business. Drugstore chains have been consolidating in part due to pressure from competitors like Caremark. Such pharmacy-benefits managers, or PBMs, have grown more quickly than retail drug outlets, thriving on a model that focuses on mail- order prescriptions, which are cheaper to fill and carry better margins than retail. Mail-order prescriptions have been a bane to drugstores, which depend on prescription sales to drive customer traffic.

Combining the two competitors will create a powerhouse with $75 billion in combined revenues and better positioned to wring lower prices from big drug manufacturers and wholesalers. The combined entity will be a more formidable competitor for Wal-Mart Stores Inc. (WMT), which sent shares of drug chains and pharmacy-benefits managers tumbling in September when it announced it will sell some 30-day generic prescriptions for $4 each.

"It's a game changer for the industry," said Edwin Vroom, president of Roanoke Asset Management in New York, which owned about 248,734 Caremark shares as of Sept. 30, according to Thomson Financial. "And it creates a much more dominant company operating both in the PBM and in the pharmacy retail space."

Investors, however, expressed concerns about integration, a damping effect on returns at CVS and the narrow premium for Caremark. Shares of CVS ended trading at $29.06, down $2.32, or 7.4%. Shares of Caremark ended at $48.17, down $1.06, or 2.2%.

Medicare Customers, Foot Traffic

In addition to pulling more of Caremark's customers into its retail outlets, CVS could benefit broadly from Caremark's control over the administration of drug benefits. That means setting co-pays for insured prescriptions, deciding what drugs are covered and in which networks, and which drugs will be made available for mail order versus which will be filled at drugstores.

Crucially, CVS will gain increased access to customers covered under the federal government's new Medicare Part D prescription drug benefit, said Ann K. Hynes, an analyst at Leerink Swann & Co. The U.S. government, with its Medicare and veterans benefits programs, is a fast-growing consumer of pharmaceuticals, accounting for nearly half of all spending on prescriptions.

The merged company will likely face pressures to fill more prescriptions through the mail, which generally is a lower-cost method of distribution, says Adam J. Fein, president of Philadelphia-based Pembroke Consulting Inc. Mail- order prescriptions, which typically are filled for 90 days each, work well with maintenance prescriptions that are taken every day for long-term conditions.

But for acute and short-term ailments that need one-time fills for painkillers or antibiotics, consumers generally prefer pharmacies. That will create an opportunity for the combined company to meet customers' needs more effectively. And when shipping prescriptions by mail, CVS will have the ability to cross-sell other items to patients, such as vitamins or diabetes strips, Hynes said.

Dispensing Through Competitors

But Fein adds that the fit could be awkward in other areas. In June, CVS acquired 700 Sav-On and Osco stores from Albertson's Inc. for $2.93 billion. While that helped the company solidify its national footprint, it still doesn't operate in all the markets covered by Caremark's dispensing network, which includes 60,000 retail outlets across the country. That network also includes a number of key rivals for CVS, among them Wal-Mart Stores Inc. (WMT) and Walgreen Co. (WAG).

"Strategically, Wal-Mart and Walgreen are going to have to make some tough decisions," Fein says. "I don't think they can sever their relationship with Caremark, because they need those customers. But they're going to be very nervous that Caremark could design programs that could favor CVS versus other programs."

Walgreen spokesman Michael Polzin said the drug chain doesn't anticipate changing the way it does business with Caremark in the wake of the merger. He noted that Walgreen has dealt with similar situations in the past, such as when Rite Aid Corp. (RAD) purchased pharmacy-benefits manager AdvancePCS in 1999 only to divest it a few years later.

CVS and Caremark had been in merger talks for more than a year, with negotiations escalating following CVS's purchase of the Sav-On and Osco stores in June, according to a person familiar with a matter. While some have speculated that the merger was a defensive move spurred by Wal-Mart's September announcement that it would begin selling some 30-day generic prescriptions for $ 4, CVS and Caremark actually paused on the news to gauge market reactions before proceeding with the deal, according to the person.

The companies have billed the deal as a merger of equals, with the new company to be called CVS/Caremark Corp. They expect $400 million in cost savings or extra revenue due to greater purchasing scale and operating efficiencies. They also see the deal adding to earnings in the first year.

While analysts were mostly upbeat on the long-term prospects of the merger, investors didn't appear to be impressed, sending CVS shares sharply lower from the opening bell.

Some analysts fretted that integrating the operations might be a burden for CVS, which already has made two large retail acquisitions this year. In addition to the Sav-On and Osco stores, CVS in September bought Minneapolis-based MinuteClinic, a chain of about 100 limited-service health clinics, for an undisclosed price.

John Heinbockel, an analyst at Goldman Sachs, said the merger would boost CVS's earnings per share and produce savings, but said those benefits would be offset by an immediate dilution to CVS's return on invested capital.

JPMorgan Chase & Co. (JPM) and UBS AG (UBS) advised Caremark. CVS was advised by Evercore Partners (EVR) and Lehman Brothers Holdings (LEH).

-By James Covert, Dow Jones Newswires; 201-938-5360; james.covert@dowjones.com

(Dinah Wisenberg Brin in Philadelphia contributed to this article.)