Walgreens Flirts With Takeover

Walgreens NASDAQ: WBA investors were surely popping a few bottles on Monday night as news broke that private equity giant KKR had made a formal offer to take the company private.

They’d already rallied as much as 17% since the start of the month on rumors of a potential takeover but the stock had cooled off when no news was forthcoming. Apparent confirmation of the offer from Bloomberg on Monday sent shares up 6% and to 7-month highs.

For a heavyweight like WBA, who has a market cap of $56 billion and is a component of the Dow Jones, S&P 500 and Nasdaq indices, a takeover like this could be a blessing. Shares of the pharmaceutical manufacturer, distributor and wholesaler were trading at prices 40% off from 2015 highs going into last weekend while the S&P 500 index is up 46% in the same timeframe.

Stiff Competition

Competition from Amazon has only been getting hotter as the e-retail giant moves into more and more product lines with seemingly impossible-to-match prices and margins. In May 2018, Amazon purchased online pharmacy PillPack which seriously spooked traditional pharma retailer investors.

Shares of Walgreens, CVS, NASDAQ: AMZN and Rite Aid NYSE: RAD all tumbled on the news. Like so many other retail-based stores, they just can’t seem to innovate fast enough in the face of Amazon’s growth.

Shares of Walgreens’ traditional competitor CVS also set all-time highs in the summer of 2015 but have dribbled down 50% since. Shares of Rite Aid, who had their heyday in the late nineties, are down over 95% since 2015. The trigger for the initial slide from highs was the growing negative press on drug prices and the feeling that Congress was going to start clamping down hard. With shares of Amazon up over 300% in the time since it’s not hard to see where the smart money has been moving to.

That’s not to say any of these pharma retailers have been idle in the face of these headwinds.

CVS NYSE: CVS is trying to reinvent itself by moving into other healthcare verticals and purchased health care insurer Aetna this time last year while Rite Aid appears to have accepted its fate and has become a pickup location for Amazon packages. Walgreens decided to double down on brick and mortar shops and has explored partnerships with doctors’ and dentists’ offices and grocers like Kroger. They went so far as to attempt a merger with Rite Aid in 2017 but this fell through. Their latest earnings report at the end of last month painted a grim picture.

Lackluster Recent Earnings

Profits fell 55% YOY, unprofitable stores were shut and an undisclosed number of employees were laid off.  The company announced plans to cut even more spending by 2022 as management appeared to be trying to stem the negative momentum and simply hold the line while these initiatives played out.

Overall the earnings weren’t as bad as analysts expected but is that really an acceptable justification for investors to remain happily long while the S&P 500 is at all-time highs? 

While Walgreens’ stock is coming out of a base at the $49 level and is up almost 30% from 2019 lows, shares are barely at 2018 levels and firmly at 2013 levels. On top of that, the stock has the unenviable tag of being the worst performer of the year so far out of all 30 components of the Dow Jones Industrial Average.

Cautiously Optimistic

With all that in mind, Walgreens investors can hardly be blamed for having a spring in their step this week while holders of CVS and Rite Aid stock will surely be green with envy and wondering when they’ll be asked to dance.

We’re still waiting for official confirmation of the offer and are a long way from anything being signed. These things have been known to fall through at the last minute so investors aren’t home and dry just yet. Keep in mind CNBC reported that this would likely be the largest leveraged buyout in history if it goes through. KKR would be taking on a $56 billion company that has $16 billion in debt on the balance sheets.

However, if there’s one private equity company that isn’t afraid to buy big, it’s KKR. They, along with TPG Capital, set the record for the largest LBO with the $45 billion purchase of Texas utility company TXU in 2007.

Walgreens’ investors have every reason to be cautiously optimistic for the first time in a long time. Let’s see how this plays out.