Walgreens’ Rationale for Selling its Benefits Business

by Trefis Team
-2.71%
Downside
76.05
Market
73.99
Trefis
WAG
Walgreen Co.
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Walgreens (NYSE:WAG) recently announced that it was selling its prescriptions benefits management business to Catalyst Health Solutions for $525 million in cash. [1] We noted recently that CVS Caremark (NYSE:CVS) is taking a different strategy and emphasizing its benefits business while Walgreens is exiting this business. (See CVS Sees Value in Pharmacy Benefits Business While Walgreens Is Selling.) We currently value Walgreens with a $43.30 Trefis price estimate, which is slightly ahead of the current market price. Below we explore how Walgreens’ divestiture will impact its business as well as look at what Walgreens’ Health Initiatives will have in store for Catalyst.

How Does this Impact Walgreens?

Exiting the prescription benefits management (PBM) business will help Walgreens accelerate its outlined strategy of broadening its pharmacy, health and wellness services by focusing on upgrading its drugstores and further expanding its retail footprint by opening more stores and/or acquiring independent pharmacies. While PBM has relatively lower operating expenses compared to filling prescriptions at the drugstores, the latter brings in additional sale of merchandise from each consumer visit. No wonder, Walgreens has been expanding its grocery offering and even started selling its own in-house beer to attract more foot traffic at its locations

How Does the Acquisition Impact Catalyst Health Solutions?

By buying Walgreens prescription benefits management unit, Catalyst expects to increase the number of prescription benefits customers from its current 7 million to 18 million, more than doubling the number of prescriptions covered from 80 million to 165 million in the process [2].

Catalyst, as of now, is the fourth largest PBM with a market cap of about $2 billion. It competes with the bigger players such as Medco Health Solutions Inc., Express Scripts Inc. and CVS Caremark Corp, each with a market cap in excess of $20 billion. Catalyst has been trying to acquire scale with the $225 million acquisition of Independence Blue Cross’s FutureScripts pharmacy benefits management business in September 2010 as another recent example.

How Much is the Impact on Walgreens?

We currently estimate Walgreens to make up almost 19.4% of prescriptions filled annually in the US. Sale of Walgreens’ PBM business brings in close to 85 million additional prescriptions filled at Catalyst. The sale will translate into Walgreens losing its share of the prescriptions filled in the US to around 17.1% in 2011.

However, the $525 million cash raised from the sale will translate into higher growth in the number of retail stores and an increase in the revenue per square foot at existing stores from upgrades. If the revenue per square foot increases from our current estimate of $323 to over $390, this could lead to close to 10% upside to our price estimate for Walgreens’ stock.

Our base estimates for Walgreens project a 6.4% year-on-year growth in the number of drugstores reaching 12,600 stores the at the end of our forecast period. Given the focus on expanding its retail footprint, there should be upside to this estimate.

You can modify the charts above to see how these factors impact our price estimates independently prior to the sale. Visit us to see our full analysis for Walgreens.

Notes:
  1. Catalyst to buy Walgreens Benefits Unit for $525 million, DealBook, March 9′ 2010 []
  2. Catalyst acquires Walgreens Subsidiary for $525 million, Gazette.net, March 11’2010 []
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