By Gene Marcial
Big shareholders at Longs Drug Stores (LDG ) are getting very impatient over the lackluster perfomance of its stock in the past two years. So they've been pressing the management and board of directors of the sixth-largest drugstore chain in North America to either sell the company or merge with a larger one to realize Longs' intrinsic worth and unlock the value of its assets. Those assets include large blocks of real estate where the company's 420 stores are located in the Western U.S., mostly in California. Although long frustrated, these investors hold out the hope that this time management and directors might just heed their advice.
"Longs is finding it very hard to compete effectively as an independent and smaller player in the fiercely competitive drugstore market," says John Rogers, CEO of Ariel Capital Management in Chicago, which manages some $5 billion and owns nearly 15% of Longs' stock. The company has a great brand name, says Rogers, with a lot of strategically located stores. But with such giants as CVS (CVS ), Walgreen (WAG ), and Wal-Mart (WMT ) successfully gaining market share, it's difficult to see Longs producing better results in the future.
Alan Snyder, president of Snyder Capital Management in San Francisco, which owns some 6.5% of Longs stock and who has also urged management to created shareholder value, says he expects the new President and CEO Stephen Roath to "do the right thing -- meaning enhance shareholer value." The company's management and directors now know "they can't continue to do what they have been doing," says Snyder.
In the past 10 years, Longs revenues have grown at an annual average rate of 1% to 2%, despite a booming California economy, says Ariel Director of Research Franklin Morton. "We have witnessed a decade of very poor financial performance," he adds.
Last year, Longs earnings rose some 11%, vs. a 22% jump at Walgreen, which has more than 3,000 stores in 41 states and is the largest drugstore chain in terms of revenues. At CVS, which has largest number of drugstores (4,100 in 29 states), earnings grew 15% last year and should increase 16% to 17% this year, says Morton.
Snyder Capital's Snyder says Longs' real value is way above what the stock is selling for today, currently 23. Trading at a deep discount to its peers, the stock should be priced at least 50% higher, says Snyder. Longs traded as high as 44 two years ago.
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Because of Longs' lagging operational results, its shares have become very depressed, says Ariel's Morton. He, too, thinks the stock could be worth 35 to 40, if it were to trade on the basis of its peers' p-e multiples, and if the company regains the Street's confidence. The 35 to 40 valuation doesn't take into account Longs' real estate holdings, "which must be worth a lot," says Morton. At 23 a share, Longs stock is trading at 14 times next year's estimated earnings of $1.61. Walgreen stock trades at p-e of 26, notes Morton.
What's Longs' response to the shareholders' clamor for value creation? "We have heard all kinds of excuses but so far," says Ariel's Morton. "Management has yet to convince us that things will improve or that shareholder value will be enhanced." The Long family, headed by Chairman Robert Long, controls 20% of the stock, and an employee group owns an additional 19%. So if a deal comes about, it has to be friendly.
"A deal should have happened a year ago," says Lehman Brothers analyst Meredith Adler, when drugstore chains were selling at higher valuations. Adler, who rates Longs a neutral, thinks this is the most propitious time for a deal because the board now has more outside directors than it did a year ago.
Ariel's Rogers and Morton think the most logical buyer would be CVS, which is seeking to become a national drugstore operator. CVS already owns the CVS Pharmacy and Revco chain, but it lacks a presence in Western states. It has a market cap of $21.5 billion, vs. Longs' $862 million. At its current price of 23, Longs is trading at 1.3 times book value, while CVS traded at 6 times book and Walgreen at 9 times.
Morton notes that based on the past six buyout transactions in the industry, Longs would be worth closer to 50 in a buyout deal. Longs Chief Financial Officer and Treasurer Steven McCann says the company is addressing the issues raised by Ariel Capital and Snyder Capital in their respective 13D filings. "We are focused on improving our operating performance," says McCann, and Longs is committed to enhancing shareholder value, which is "consistent with our goals."
Marcial is Business Week's Inside Wall Street columnist