A leveraged buyout of Walgreens Boots Alliance would be a tough transaction to pull off, given the company’s size and the amount of equity likely needed to finance a deal.
There were reports Monday that KKR (ticker: KKR) has formally approached Walgreens (WBA) about a deal to take private the drugstore chain, which now has a market value of $57 billion. If the transaction went ahead, it would be the largest LBO in history.
Walgreens shares were up 6.3% to $62.96 in response to the news.
Walgreens didn’t immediately respond to a request for comment, while KKR declined to comment.
A week ago, Steve Schwarzman, the CEO of Blackstone Group (BX), the largest private-equity firm, said a Walgreens buyout would be a “stretch,” citing the equity needed to pull off such a deal.
Then there are the fundamentals. Walgreens has struggled due to challenging conditions in the retail pharmacy business both in the U.S. and in the U.K. Its adjusted earnings for its latest fiscal year, ended in August, were down 0.5% to $5.99 a share. The company projects “roughly flat” earnings per share for the current fiscal year.
Unlike rival CVS, which has owns a large health insurer, Aetna, and a big pharmacy benefit-management business, Walgreens is primarily a retail drugstore business. Private-equity firms generally prefer to buy businesses with growing profits to facilitate debt reduction.
The math illustrates the challenge. It would probably take a price of $75 to $80 a share to gain shareholder approval. Walgreen shares were hit hard earlier this year, but the stock traded at $86 last December and for nearly $100 in 2015.
At $77.50, Walgreens would be valued at $70 billion. It has $16 billion of net debt, which would give it an enterprise value of $86 billion in this LBO scenario. Its annual earnings before interest, taxes, depreciation and amortization, or Ebitda, are around $8 billion.
If Walgreens wanted to keep its ratio of debt to annual Ebitda at six, it could take on no more than $35 billion of borrowings, meaning that KKR would have to write an equity check for $35 billion. Schwarzman commented last week that getting $20 billion of equity for an LBO wouldn’t be easy. At CVS, debt is about four times annual Ebitda.
Wall Street analysts are lukewarm to negative on Walgreens. Only one of the 24 who follow the stock rate it at Buy or the equivalent, according to Bloomberg. J.P. Morgan analyst Lisa Gill wrote recently in a client note on Walgreens that “growth will remain constrained in the near term, based on the difficult retail pharmacy backdrop, limited benefit from partnerships, incremental investments” and other factors. She has a Neutral rating on the shares.
If Walgreens tried to go private at $70 or less, it could face considerable opposition from shareholders, who would argue that KKR is underpaying. At $70, KKR would be valued at just 12 times projected earnings in the current fiscal year.
Our bet is that if the company does try to pull off an LBO, Walgreens CEO Stefano Pessina, who is the largest shareholder, would have to agree to a so-called majority of the minority vote. Under that scenario, his 16% stake wouldn’t count. Michael Dell took that approach in 2013, when he took Dell private.
Then there is the exit strategy. Given the tough conditions and investments needed in the retail pharmacy business, it is uncertain what kind of valuation KKR could get on a leveraged Walgreens when it presumably would seek to take the company public again in the next decade.
A better option for the company, as Barron’s noted last week, would be a sale to Berkshire Hathaway (BRKA), whose CEO Warren Buffett, is seeking an elephant-sized acquisition that would let him put to use Berkshire’s $128 billion in cash. Berkshire wouldn’t comment on that speculation last week.
Source: Barron’s