Looking at Walgreen Bid for Drugstore.com

by Trefis Team
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Acquisitions are nothing new for the U.S. pharmacy industry, which is undergoing consolidation. CVS (NYSE:CVS) acquired Caremark’s pharmacy benefit management business in March 2007 and Walgreen (NYSE:WAG) expanded its retail footprint in New York with the acquisition of Duane Reade in April 2010. But it isn’t everyday that we hear about a premium of almost 112% over the target’s closing share price being offered in a takeover bid, which is the premium Walgreen bid for for Drugstore.com with its $429 million offer. [1] According to Bloomberg, over the past three years, the buyers of the 85 online retailers in the US paid an average premium of 21% over the target’s average price over 20 trading days before the announcement [2] Given Walgreen aggressiveness in bidding, we decided to take a closer look at this deal.

We currently value Walgreen with a $43 Trefis price estimate of its stock, at close to 10% premium to its current market price.

Why Does Walgreen Want to Grow its Online Business?

To focus solely on its retail pharmacy business, Walgreen recently agreed to sell off its pharmacy benefit management business to Catalyst Health Solutions for $525 million in cash. [3] Walgreen already has the largest retail pharmacy network with over 7,600 drugstores nationwide. So Walgreen increasing its focus on the online channel does not come as a surprise.

Walgreen is already the leader in the online retail pharmacy business in the U.S. with some 8 million unique visitors at walgreens.com in February compared to 4.6 million for CVS Caremarks’  and 3.9 million for Drugstore.com. Drugstore.com operates its namesake website along with Beauty.com, SkinStore.com and VisionDirect.com. It is the eighth largest online retailer in the U.S. and so the acquisition brings Walgreen substantial business over the Internet and fits with Walgreen’s retail-focused growth strategy.

But, Why the Exceptionally High Valuation for Drugstores.com?

So while Drugstores.com would help Walgreen increase its presence online and benefit from the high growth in online pharmacy sales, it still doesn’t explain the exceptionally high valuation. Basically, the acquisition is not for drugstore.com’s over 3 million unique visitors (as of February 2011), but instead targets the 60,000 products that drugstore.com sources directly from the vendors through the relationships developed over time since its foundation in 1998. So, the acquisition not only increases the number of online shoppers,but also increases sales per visitor at walgreens.com due to the enlarged product offering.

The deal is actually cheaper than it appears outright. While drugstore.com reported revenues of $456 million in 2010, it has never posted a full-year profit, something not unusual for young online retailers. The series of drugstore.com’s past losses offer Walgreen a tax advantage, approximated to be around $80 million. [4]

Walgreen believes that adding these products to its own online website shall ‘significantly speed up its online strategy’… put simply, increase Walgreen’s business over the Internet. As for the timing of the deal, liquidity wasn’t much of a concern given the recent all-cash sale of Walgreen’s pharmacy benefit management business.

See our full analysis for Walgreen.

Notes:
  1. Walgreen To Acquire Drugstore.com For $429 million, WSJ, March 24′ 2011 []
  2. Walgreen Buys Drugstore.com For $429 Million To Add Sites, Bloomberg, March 24′ 2011 []
  3. Walgreen’s Rationale For Sellings Its Benefits Business, Trefis, March 22′ 2011 []
  4. Walgreen’s Need For Speed, WSJ, March 25′ 2011 []
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