Walgreen’s Stock Gets Investors’ Boots As Deal Is Scrutinized

by Trefis Team
-5.07%
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Trefis
WAG
Walgreen Co.
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Walgreen‘s (NYSE:WAG) stock has slumped since it announced the Alliance Boots deal. The stock has made back some of these losses after the management attempted to reassure investors about the rationale behind its decision to purchase a 45% stake in the European pharmacy-led health and beauty retailer in a $6.7 billion cash-and-stock deal. But the stock reached a low of $29 on Monday as investors continued to be worried about the price, timing and necessity of the deal in the backdrop of an uncertain European economy. Walgreen competes with CVS Caremark (NYSE:CVS) and Rite Aid(NYSE:RAD) in the U.S.

View our analysis for Walgreen

Investors Skeptical About Cost, Timing and Wisdom of the Deal

Walgreen acquired a 45% stake in Alliance Boots, paying $4 billion in cash and 83.4 million in shares and it intends to acquire the remaining stake by 2015. The market reacted sharply to the news, raising doubts over the cost and timing of the deal and the risks associated with increased exposure to current European economic uncertainties. Many investors had hoped that Walgreen would buy its own shares back rather than go for an acquisition such as this.

The deal might also have an adverse impact on Walgreen’s credit rating due to the increase in debt to $11 billion. The pessimism dragged the stock down to a new low near $28-29. The stock has already lost significant value, down from the $45-levels in June 2011, after ending its contract with pharmacy benefit manager Express Scripts that accounted for 12% of its business in 2011.

Walgreen Sees Long-Term Sense in the Trans-Atlantic Alliance

The Walgreen and Alliance Boots deal creates the first global pharmacy business with 11,000 stores in 12 countries. It provides Walgreen and Alliance Boots a large platform for further international expansion based on Alliance’s experience in expanding into new markets such as China and Latin America, along with the opportunity to turn Alliance Boots into a global wholesaler. Over time, it is likely to enter new markets by first acquiring wholesalers and subsequently expanding retail presence.

While investors see the deal as a big risk at a time when the European governments are ridden with debt worries, Walgreen sees Alliance Boots as a long-term bet by creating a global brand. It expects the timing of the deal to give them the advantage to stay ahead of the industry that is gradually heading toward consolidation and globalization. Walgreen expects the deal to provide cost and revenue benefits of $100 million to $150 million in the first year and $1 billion by the end of 2016 for both the companies. The two together will also be the world’s largest buyer of prescription drugs and health products which will give them leverage to negotiate better prices for generic drugs and other non-pharmacy products.

Alliance Boots is the largest European pharmacy-led drug retailer and health and well being products seller that generated $40 billion (£25 billion) in revenue and $2 billion in operating income in 2011, and we believe the market may be discounting the combined entity’s lone-term earnings and growth potential over short-term uncertainties. Nonetheless, integrating a company of the size of Alliance Boots is unprecedented and a challenging task for Walgreen.

We are in the process of revising our $35 Trefis price estimate of Walgreen stock.

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