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Summary

  • ¨Investors¨ dump shares in Walgreen as it no longer considers a tax-inversion move.
  • This news comes after the company acquires the remainder 55% stake in Alliance Boots.
  • The 2016 adjusted earnings outlook was soft compared to ¨consensus¨ estimates as well.
  • Yet all of this news, and the subsequent share sell-off create a compelling opportunity in my eyes.

Investors in Walgreen (NYSE:WAG) have some pain to digest following the recent events.

The company announced the acquisition of the remaining 55% stake in Alliance Boots while it also updated the market with a 2016 earnings outlook. Yet the real big bad news was that the company is no longer considering an inversion move towards Europe.

This bad news show triggered a big sell-off last week, in what has created an appealing opportunity in my opinion, which I eagerly grabbed.

The Exercise Of The Option To Fully Acquire Alliance Boots

Last week Walgreen announced that it has exercised its option to fully acquire Alliance Boots ahead of the initial timeline for an exercise of this option between February and August of 2015.

This exercise follows the initial purchase of a 45% equity stake in Alliance Boots back in the summer of 2012. Given the current exercise, the full ownership and deal is anticipated to close as soon as the first quarter of 2015.

Organizational Implications

Following the integration the new Walgreen Alliance Boots company will operate in four major divisions. Walgreen continues to be the US pharmacy chain. Another divisions is Boots in the UK and Ireland representing the pharmacy and beauty retailer assets in those countries. On top of that is the formation of Pharmaceutical Wholesale and the Global Brands Group.

The main areas of focus remains of course the core retail experience which the company tries to differentiate versus its competitors. The company will additionally focus on global pharmaceutical services as well as the integration of pharmacy and health care in a continued blurring industry lines.

The Corresponding Financial News

So far the good news, as investors did not like the financial implications of this deal. For starters is the decision of the company to remain incorporated in Deerfield Illinois, while not making a so popular inversion move towards Europe in order to save on taxes. CEO Gregory Wasson said the board was not really confident that an inversion would be the best move with politicians stepping up their backlash, as consumers have considerable power given that Walgreen is very much a retail business.

Adjusted earnings for 2016, the first full year after completion of the deal, are seen between $4.25 and $4.60 per share. Included in this guidance is the assumption of accelerated cost savings which are anticipated to run at a billion saving rate by 2017.

To please investors during this integration process, Walgreen's board has announced a new $3 billion share repurchase program while hiking the quarterly dividend by 7.1% to $0.3375 per share.

To acquire the remainder 55% stake, Walgreen will spend roughly $5.29 billion while it also issues about 144.3 million shares to Boots' shareholders. Based on the prices prevailing before the news hit the market, this valued the remainder of the stake in the company at about $15 billion. This came after the company initially paid just $6.7 billion for the initial 45% stake in Alliance Boots

Valuation Implications

The new Walgreen's Alliance Boots will operate over 11,000 stores in 10 countries making it the largest purchaser of prescription drugs as its wholesale and distribution network will deliver to more than 180,000 pharmacies, doctors and hospitals across the globe. In total, the company will provide employment to some 350,000 workers serving over a 100 million in loyal members.

The new combination aims to post sales of $126 to $130 billion by 2016 on which it aims to report earnings of $4.25 to $4.60 per share on an adjusted basis.

At the end of the third quarter, Walgreen operated with about 968 million shares outstanding. Add to that the 144 million in newly to be issued shares and the total share count will increase towards 1.11 billion shares. Ahead of the deal, Walgreen itself held about $2.1 billion in cash while operating with $4.5 billion in debt.

This modest debt position of about $2.4 billion will increase towards $7.7 billion given the cash component of the exercise of the remainder 55% stake. It should be noted that Boots held about 5 billion British Pounds in net debt earlier this year, adding another $8.5 billion in debt, resulting in a total net debt position of about $16 billion.

With 1.11 billion shares outstanding, and a share price which has fallen to about $62, equity is now valued at close to $70 billion. This values the combination at about 0.5 times anticipated sales for 2014 and about 13-14 times adjusted earnings.

Final Takeaway

The latest news flow has sent shares some 20% lower from their highs set around $76 in June of this year. The double whammy of no inversion move and perhaps slower integration pace are the drivers behind the anticipated shortfall in earnings.

Back in June I last took a look at the company's prospects following the third quarter earnings report. At the time the company warned for slower than anticipated progress in the Alliance Boots deal. While operational achievements might be behind schedule, the actual deal closure anticipated much quicker than anticipated. I acknowledged the risks related to the fact that a tax inversion could no longer occur, while the slower progress has been disappointing as well.

This update and the very fierce correction driven by the fact that no tax inversion is taking place and that progress is a bit slower than anticipated, provided me with a great entry point in the high fifties. I was very pleased with the market providing me an entry point in the $58s.

At 13-14 times 2016s anticipated earnings, which is less then two years away, and with potentially greater synergies creating upside to these earnings per share estimates, I am happy with my position at current levels. Despite a rebound to $62 per share, I will hold on to my position despite a quick 6% gain.

Source: Walgreen: Bad News Show Creates A Compelling Opportunity