Jun

21

Yesterday's announcement that WAG will buy Boots (from KKR) provides a textbook example of the lifecycle of corporations. For decades, WAG was a mid-teens growing company (longterm return S&P500-plus 500 bp), with a stellar balance sheet and a strong competitor to CVS and other small retailers. Their growth was mostly driven by new-store openings, the organic growth in prescription demand, and the gradual expansion of general merchandise and food product offerings. Yet, the ubiquity of their stores, the evolution of the prescription drug market, and most recently, the loss of one of their largest pharmacy customers (they refused to accept the realities of the current market) left them with negative comps and all of the arrows pointing downwards.

So, what do they do? They raise their dividend. Good. They buy back stock. Good. They announce a massive lateral acquisition at a very rich 11X Ebitda. Very very very bad.

They will pay for the Boots acquisition with mostly debt, which will whack their credit rating; produce no obvious growth; and make them bigger, not better.

This smells of desperation. Not strategic vision. Boot's CDS(debt) had been trading at +428 bp ; but immediately tightened by about 250 bp on the deal. In contrast, WAG's enterprise value is about 5.4x EBITDA and CVS trades at 7.5x EBITDA. So even if one believes in a 20% or 30% takeover premium, that still doesn't justify an 11x EBITDA multiple. (WAG justifies the premium because they will have "synergies" in negotiating prices with generic drug manufacturers. But given the nuances of global pharmaceutical pricing, and their inability to cut a deal with ExpressScripts, this sounds like continued denial of market reality.)

Who negotiated this deal? Did they hire Leo Apotheker when I wasn't looking? http://en.wikipedia.org/wiki/L%C3%A9o_Apotheker

One submits that WAG has decided to aggressively pursue the zombie world of no-growth companies who run faster and faster to stand still, rather than running their existing businesses better — and accepting (rather than denying) the changing competitive landscape.

And if I worked for KKR, at the same time that I was selling Boots at 11x EBITDA, I'd be thinking about using the proceeds to eventually buy Walgreen stock at 5x EBITDA.

JetCat1 writes: 

Seems like an international problem of shop front retailers, having huge internal problems trying to make massive adjustments with policy, in turning the ship around. It would appear, it shouldn't be so difficult, but one would think no one wants to make the big call that are needed, early in the piece. Just like having replays at the Euro Football championships 2012. Ukraine gets the ball over the line, still no goal against England. At what stage has technology not being up to the job, of having a TV replay settle the matter in the last 30 years, and still the rubbish of bad calls persist. It seems the larger the flexionic group, the lack of balls, for want of a better word, to stand up and say "this isn't good enough, this is the direction that needs to be taken".

Rocky Humbert replies: 

I respectfully disagree with both your metaphors and your conclusions. If WAG has simply re-negotiated their ExpressScripts deal at the market-clearing price, their stock would be north of 40. Not south of 30. Walgreens is an excellent operator. It's not about turning the ship around. It's about living in today's world. Not yesterday's. Put simply: The competitive landscape for retail drug stores have changed over the past several years. WAG used to be a price maker. But they are now a price taker. Rather than accepting this reality, they decided to pay (too much) for another price taker (Boots) with the vision of re-establishing their negotiating (price-making) power over suppliers … in the spirit of Walmart's business strategy. It's not crazy, and if they had paid a reasonable price for the acquisition, it might have even worked a little bit. But if you pay too much, you are doomed. Their transaction has all of the hallmarks of a McKinsey/Bain/Booz/BCG study on it. If I were the CEO, I would have renegotiated the deal with Express Scripts.And some day, when KKR was really desperate, I might have let them him my bid. At 5x Ebitda.
 


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