Walgreen (WAG), one of the largest retail pharmacy chains in the US has decided to acquire online retailer drugstore.com for a total enterprise value of $409 million. Stockholders of the online retailer, with more than $456 million in sales in 2010, will receive $3.80 in cash for each share, representing a 102% premium over its 30-day average closing price.
The transaction, subject to regulatory approvals, will close by the end of June 2011. Walgreen expects the deal to dilute its earnings by 3 cents in the fourth quarter of fiscal 2011 as well as in fiscal 2012 (by 3-4 cents) and 2013 (2 cents).
Walgreen’s objective has been to use its cash balance strategically to enhance its business prospects. With this aim, earlier this month, the company decided to sell its pharmacy benefit management (PBM) business to Catalyst Health (CHSI) for $525 million in cash. Subsequent to this deal, Walgreen will be able to better focus on its 7,700 drug stores.
Walgreen generated $886 million in cash flow from operations during the second quarter of fiscal 2011 and $2.1 billion for the first half of fiscal 2011. At the end of the quarter, the company had $2.2 billion in cash and cash equivalents, down from $2.5 billion at the end of February 2010.
In order to make the best use of available funds, Walgreen has scaled down its plan of opening stores. We believe this decision will benefit the company as the new stores take 2 to 3 years to break even and will conserve cash. The company expects an organic store growth of 2.5%−3% in fiscal 2011.
Our Recommendation
We are encouraged by Walgreen’s recent decision to sell its PBM business to enable it to better focus on its drugstores. The latest decision to acquire drugstore.com should further enable it to target more than 3 million online customers and expand its online product offering.
Moreover, the benefits from CCR rollout and rewiring initiative will be experienced gradually. Leveraging on its strong cash balance, the company is well equipped to pursue suitable acquisitions in future. However, Walgreen has been impacted over the past few quarters by high unemployment levels and lower discretionary spending.
We have a ‘Neutral’ recommendation on the stock, which also corresponds to a Zacks #3 Rank (hold) in the short-term.
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