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Walgreens-Boots LBO

By Thor Höfs and Jakob Jones

Initially posted on the BSPEC blog

With a market capitalization of over $52 billion and a prominent position in the American, British, and global pharmaceutical market, the Walgreens Boots Alliance is now at the center of what could be the largest leveraged buyout in history. The offer made by KKR on the 11th of November 2019 has an estimated value of $70 billion, 50 of which would be debt financing and the remaining 20 would be equity.

History of Walgreens

Established in 1901 as a simple food front store in Chicago Illinois, the company rapidly grew in the 1920s and 1930s, despite the Great Depression, mainly because of the sale of prescribed alcohol. Over the following 70 years, Walgreens increased its number of stores by 100 times starting in the first half of the 20th century (in 1934 it owned about 601 stores) to the beginning of the following century (in 2007 it opened its 6,000th store in New Orleans, Louisiana).

In the 21st century what had become the second-largest pharmacy-store chain in the United States looked to expand to retain its position in the pharmaceutical market which was under threat by the emerging online retailers. In fact, in 2010 the company acquired Duane Reade (a New York City-based chain of drug stores) and the following year it added drugstore.com to its portfolio for $491 million. In 2012, Walgreens made a $6.7 billion acquisition consisting of a 45% share in Alliance Boots following the leveraged buyout of the British company in 2007 by KKR and Stefano Pessina, who would become the CEO of the Walgreens Boots Alliance in 2015. Just two years later, in 2014 Walgreens acquired the remaining 55% of Alliance Boots and merged the two companies by forming the Walgreens Boots Alliance.

In order to keep up with its main competitor CVS’ merger with insurer Aetna, in 2015 Walgreens unsuccessfully attempted to takeover RiteAid and two years later ended up buying 1,932 RiteAid stores for $4.38 billion. In the subsequent three years, the company closed approximately 600 stores and in 2019 it announced it would close another 200 stores. Meanwhile, retail giant Amazon.com bought online pharmacy Pillpack in what has been speculated as an attempt to expand into the pharmaceutical industry.

The dynamics of the deal

The Walgreens Boots Alliance is currently facing substantial challenges as it is reducing its workforce and closing stores to reduce costs by $1.8 billion per year by 2020. Its stock price has fallen about 20% from January to October of the previous fiscal year but it has risen by 6% when the deal was announced Monday, November 11th.

In order to save the Walgreens Boots alliance, an offer valued around $70 billion has been made by the private equity firm KKR to take the company private. Taking the company private would ensure an easier restructuring of the company itself. For example, the Walgreens Boots Alliance would not be subject to the obligations of a public company such as quarterly demands by shareholders. In addition, this deal may see the participation of the company’s CEO Stefano Pessina who in the past had already had a relationship with KKR. As a matter of fact, the CEO’s 16.5% share of the company, valued at around $9 billion dollars, may be instrumental in the success of this leveraged buyout.

Is the deal feasible?

As Walgreens will have to take on approximately $50 billion of debt in the largest LBO ever recorded, questions arise whether such a deal is feasible. Following the acquisition of 1,932 Rite Aid stores, Walgreens introduced its cost-cutting program, which is expected to save more than $1 billion by the end of the third year. The size of Walgreens with more than 18,750 stores in 11 countries allows for further cost-cutting, but will require strategic diligence to determine which regions need restructuring, and which should be exited. But since Walgreens already initiated the restructuring, it is questionable how much potential value can still be created in the case of a potential buyout. This would subsequently limit Walgreens and KKR to the $70 billion LBO if the funding can be achieved at all, but a higher premium seems out of reach.

The $70 billion buyout would require KKR to collaborate with other investors and it is currently talking to a number of its own investors to explore the possibility of breaking the current record of the $45 billion LBO of energy company TXU in 2007. The necessary $50 billion of debt appear to be feasible in a time of historically low interest rates, but Walgreens, currently holding a BBB credit rating, needs to maintain an investment-grade rating among investors for at least a considerable amount of debt in order to access the $8 trillion investment-grade bond market. Nevertheless, at least $20 billion in equity will be necessary to pull off a deal of that size, and raising this sum in current market conditions will be the chief problem for KKR. In any case, KKR is dependent on the management and Stefano Pessina will have to contribute largely to the deal considering his 16.5% stake.

Implications on the PE market

The deal would overtake TXUs LBO in 2007 by about 55% in size and could push LBOs into the next dimension if carried out successfully. However, it will be necessary to watch the sources and proportions of funding before predicting future outcomes. The low interest rate environment certainly supports carrying out the deal and will support further deals, as long as interest rates do not hike substantially. However, it depends on the risk appetite of investors to see if further deals can be completed.

TXU went bankrupt in 2014, seven years after its LBO, as KKR and TPG expected natural-gas prices to rise. However, the economic crisis reduced the demand for power and technological revolution resulting in lower electricity prices. Subsequently, the investors were unable to service the large amount of debts, so that TXU was forced to file for bankruptcy. Therefore, investors must be especially wary when entering LBOs with these debt proportions and should pay high attention to the underlying assumptions of a potential deal. However, if KKR and Walgreens can successfully complete this LBO, they will pave the way for larger buyouts in the future.

Editor: Eric Peghini

Authors: Jakob Jones, Thor Höfs

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Bocconi Students PE Club
The Bocconi Students Private Equity Club (BSPEC) is a student-led organization at Bocconi University. The club publishes articles related to private equity and venture capital, conducts interviews with active PE professionals and hosts events featuring funds and advisors. BSPEC is one of the oldest and most active student associations at Bocconi University and its alumni are currently employed at top tier investment banks and PE funds. Learn more at https://bspeclub.com/

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