3 Reasons to Flee Walgreen

by Susan J. Aluise | June 26, 2012 10:14 am

When Walgreen Co. (NYSE:WAG[1]) announced last week that it will spend $6.7 billion for a 45% stake in European pharmacy and beauty chain Alliance Boots, the news sent investors running from the stock.

That rude reception to the biggest deal in WAG’s history is another sign that in the heated competition for pharmacy-sector dominance, the market worries that Walgreen is still struggling to fill the right prescription at the right time.

WAG shares fell by nearly 6% last Tuesday on news of the deal. It didn’t help that the pharmacy giant announced it on the same day it reported an 11% drop[2] in quarterly earnings.

On the surface, WAG’s deal is a coup. Boots, a major European retail and wholesale pharmacy company, boasts 3,300 pharmacies in 12 countries and more than 300 drug-distribution centers in more than 20 countries. The Boots deal also gives Walgreen the option to acquire the rest of the major European drug distributor within three years for an additional $9.5 billion.

Beyond its pharmacy business, Boots has an England-based R&D unit that develops health and beauty products — some of which are sold through arch rival CVS Caremark’s (NYSE:CVS[3]) retail stores. WAG’s health and beauty operations should benefit from those synergies.

Since WAG is primarily focused on extending its retail empire, the Boots deal makes sense on paper. “This is a chance to create the world’s first global pharmacy and health-care enterprise,” Walgreen CEO Greg Wasson said in an interview last week[4].

And the move seems in line with WAG’s recent acquisition strategy: It acquired 199 stores last year and completed its $225 million acquisition of BioScrip Inc.’s (NASDAQ:BIOS[5]) specialized pharmacy and mail-order operations in May.

Company executives say the Boots deal will create a combined company that generates $130 billion in annual revenue by 2016. Synergies could save the company $150 million in the first year and as much as $1 billion in four years. But that $1 billion in savings materializes only if WAG buys the other 55% of Boots.

So with all that good news, why did Wall Street punish WAG stock? Because investors aren’t convinced that this is the best medicine for what ails Walgreen.

Here are three reasons investors should walk away from Walgreen after the Boots deal:

It Exposes WAG to Weakness in Europe

When making major strategic acquisitions, timing can be as important as the terms of the deal. And most analysts were wary about WAG doing this deal at a time of such great uncertainty regarding Europe’s economic health. “In our view, the timing of the acquisition is less than ideal, the execution risk is likely elevated across the enterprise, and financial flexibility is reduced at a time when share repurchase was more accretive than ever before,” William Blair analyst Mark Miller wrote in a note to clients.

Express Scripts’ Medco Acquisition Increases the Pressure

WAG stock has been bludgeoned over a messy divorce from Express Scripts (NASDAQ:ESRX[6]), the nation’s largest pharmacy-benefit-management (PBM) company. Earlier this month, ESRX and WAG dropped the lawsuits they’d filed against each other, but they so far they haven’t inked a new contract that would enable WAG to fill 88 million prescriptions from the company worth some $5 billion in annual sales.

Walgreen remains part of several major PBM networks, including UnitedHealth’s (NYSE:UNH[7]) OptumRx and Medco Health Solutions, but ESRX’s acquisition of the latter in a $29.1 billion deal earlier this year could complicate that relationship. Medco accounted for more than 100 million Walgreen prescriptions in 2011.

Boots Can’t Solve WAG’s Problems At Home

Facing brutal competition from CVS and the discount pharmacies operated by retailers like Walmart (NYSE:WMT[8]) and Target (NYSE:TGT[9]) Walgreen is struggling to boost sluggish sales. WAG’s same-store sales fell by nearly 6% in May – the fifth straight month of declines. Same-pharmacy sales dropped by 8.5% and store traffic was more than 2% lower last month.

The bottom line: WAG’s Boots acquisition could be a healthy choice in the long term, but it does little to alleviate WAG’s pain and suffering now. I believe taking its eye off the challenges it faces in its U.S. stores — particularly the need to resolve the Express Scripts feud quickly to not lose Medco prescriptions in 2013 — is a distraction the company can ill afford.

And that’s the best short-term scenario. All bets are off if Europe sinks deeper into its economic abyss.

Although I recently outlined one opportunity for WAG[10], I believe the Boots deal takes any potential bid for Rite Aid (NYSE:RAD[11]) off the table for now.

If you want to play the pharmacy sector, I’d pass on WAG and buy CVS with a target of $50.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

  1. WAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=WAG
  2. on the same day it reported an 11% drop: https://investorplace.com/2012/06/walgreens-to-pay-6-7b-for-stake-in-alliance-boots/
  3. CVS: http://studio-5.financialcontent.com/investplace/quote?Symbol=CVS
  4. CEO Greg Wasson said in an interview last week: http://articles.chicagotribune.com/2012-06-20/business/ct-biz-0620-walgreen-boots-20120620_1_walgreen-shares-walgreen-plans-pharmacy
  5. BIOS: http://studio-5.financialcontent.com/investplace/quote?Symbol=BIOS
  6. ESRX: http://studio-5.financialcontent.com/investplace/quote?Symbol=ESRX
  7. UNH: http://studio-5.financialcontent.com/investplace/quote?Symbol=UNH
  8. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  9. TGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=TGT
  10. I recently outlined one opportunity for WAG: https://investorplace.com/2012/05/which-is-healthier-cvs-or-walgreens/
  11. RAD: http://studio-5.financialcontent.com/investplace/quote?Symbol=RAD

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