Walgreen will pay $4 billion cash and the rest in stock for its biggest-ever deal, with an option to gain full control in about three years, the companies said today in a statement. The stake is being acquired from a group led by KKR & Co. and Alliance Boots Chairman Stefano Pessina, who purchased the company for 12.1 billion pounds ($19 billion) five years ago.
The combination gives Walgreen and Alliance Boots, the U.K.’s largest drugstore-chain company, more than 11,000 stores in 12 countries and 370 distribution centers to pharmacies, doctors and hospitals. The deal also may help Walgreen cope with the loss of U.S. customers after its contract with employee- benefits manager Express Scripts Inc. (ESRX) ended last year.
“There is no question that this deal does diversify Walgreen away from the United States and creates a separate profit stream that could counter any added Express Scripts- related hits,” John Heinbockel, a Guggenheim Securities LLC analyst in New York, wrote today in a note to clients. He rates Walgreen buy.
The loss of revenue from Express Scripts customers contributed to an 11 percent decline in Walgreen’s fiscal third- quarter profit, the retailer said today in a separate statement.
Walgreen sank 5.9 percent to $30.09 at the close in New York. The Deerfield, Illinois-based company’s shares have declined 9 percent this year.
Walgreen will have an option to buy the remaining 55 percent of Alliance Boots, which is based in Zug, Switzerland, and has an operational hub in Nottingham, England. KKR and Pessina will become shareholders in the combined business. Pessina, an Italian billionaire, said on a conference call that he will own an 8 percent stake in Walgreen and doesn’t want to take money out.
The transaction “will change the dynamic of the industry,” said Pessina, who will join Walgreen’s board along with KKR’s Dominic Murphy upon the completion of the initial investment in Alliance Boots.
Wasson said the deal is “a partnership, not a takeover,” adding that talks between the companies have been taking place for 18 months. Walgreen will assume Alliance Boots’s debt in the second phase of the tie-up, he said.
The deal will lead to cost and revenue benefits across both companies of $100 million to $150 million in the first year and $1 billion by the end of 2016, according to the statement.
Walgreen, which was advised by Goldman Sachs Group Inc. (GS) and Lazard, forecast the transaction will add 23 cents to 27 cents a share to diluted earnings per share in the first year after completion of the initial investment, excluding one-time costs. Alliance Boots was advised by Centerview Partners.
Some investors are skeptical about the projections for additional per-share earnings next year, said Brian Sozzi, an independent analyst in New York.
“The market doesn’t believe the projections,” Sozzi said in a telephone interview. “There is big-time integration risk here putting together a giant U.S. pharmaceutical business with a giant U.K. pharmaceutical business.”
The U.S. drugstore owner has lined up $3.5 billion of short-term debt financing from Goldman Sachs and Bank of America Merrill Lynch to help fund the acquisition, according to a statement from KKR. Walgreen plans to replace the bridge facility with permanent financing at a later stage.
KKR, which invested $2.45 billion in Alliance Boots for a 33 percent stake, will get $1.8 billion in cash and 7 million Walgreen shares valued at about $200 million, in return for the sale of a 15 percent stake. KKR had $62.3 billion in assets under management as of March 31.
While KKR is getting most of its original investment back, the rest of its return depends on whether Walgreen decides to exercise its option. At the current share price, the return would be 2.7 times KKR’s investment in pounds, and 2.2 times in dollars, Murphy said in a telephone interview today.
KKR rose 6.8 percent to $12.48 in New York trading.
Walgreen’s third-quarter net income fell to $537 million, or 62 cents a share, from $603 million, or 65 cents a year earlier. Excluding some items, profit was 63 cents a share. The average estimate of 20 analysts surveyed by Bloomberg was 63 cents. Sales fell 3.4 percent to $17.8 billion, trailing analysts’ average $17.9 billion estimate.
Sales at stores open at least a year dropped 6.6 percent after the end of Express Scripts contract Dec. 31 led to fewer visits by customers.
In April, Express Scripts, based in St. Louis, acquired Medco Health Solutions Inc., a rival pharmacy-benefit manager that also has a contract with Walgreen.
Wasson said today on a conference call that the Alliance Boots transaction isn’t linked to concerns that Medco may cancel its arrangement with Walgreen.
“We’ve said that we’ve had a contract in place for many, many years,” Wasson said. “We’re willing to keep serving those customers.”
Alliance Boots owns more than 3,200 stores globally. The company last month reported a 12 percent increase in annual profit, driven by its wholesale pharmaceuticals business. Pessina said at the time that he was looking for a “transformational” merger as soon as this year to help turn Alliance Boots into a global wholesaler.
The deal also will help Walgreen expand into emerging markets, Wasson said.
“Walgreens is still a U.S. business so its desire to achieve a more global footprint will be a game-changer,” said Bryan Roberts, director at Kantar Retail in London. “This gets them into Europe and Asia.”
The stake purchase is Walgreen’s biggest deal, exceeding its $1.08 billion acquisition of U.S. drugstore chain Duane Reade Holdings Inc. from private-equity firm Oak Hill Capital Partners LP in 2010, according to data compiled by Bloomberg. In 2008, CVS Caremark Corp. (CVS) outbid Walgreen to buy another U.S. chain, Longs Drug Stores Corp.
There have been more than 230 drugstore takeovers globally in the past decade, according to data compiled by Bloomberg. The median buyers paid almost 30 similar deals was 7.9 times earnings before interest, taxes, depreciation and amortization.
Alliance Boots Loans
Alliance Boots loans jumped in London today as Walgreen’s option to take full control boosted optimism that lenders will be repaid at par before the final maturity of the loan. The senior loans denominated in pounds were quoted at 96.5 pence on the pound as of 11:30 a.m. in London, up from 92.5 pence yesterday, according to Mizuho Corporate Bank Ltd.
Credit-default swaps on Alliance Boots dropped 183 basis points to 237, the lowest since Feb. 2011, according to Bloomberg data at 2:25 p.m. in London.
Walgreen had 8,210 locations at the end of fiscal year 2011. The chain, which also sells general merchandise, got 65 percent of its revenue that year from prescription drug sales.
The initial investment by Walgreen and its option to purchase more of Alliance Boots doesn’t include the company’s minority interest in Galenica AG (GALN), the world’s largest maker of iron replacement drugs. That investment will be continue to be owned by Alliance Boots and its existing shareholders, KKR said.
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