Drugstores fight for survival
Posted
Sep 18 2008, 11:40 AM
by
Anthony Mirhaydari
Rating:
Lost in all the recent market turmoil has been the corporate fistfight between Walgreens and CVS over Longs Drug Stores.
At issue is whether the traditional drugstore can survive in its current form. Grocery stores and big-box retailers have been allowed to add pharmacies and bring lower prices through economies of scale, such as Wal-Mart's $4 generic drug offer, as well as the added convenience of one-stop shopping. Many governmental agencies and private insurance companies are adding mandatory mail-order programs.
So how is your neighborhood drugstore, with a limited selection of greeting cards, shampoos, and first-aid supplies, going to compete? Survival will come through strength in numbers. By growing the number of store locations, the drugstores hope to capitalize on that other facet of convenience: Proximity through multiplicity.
Though this lens, the attempted acquisition of Longs makes beautiful sense: With its well-established presence in the notoriously tough-to-crack California market, Longs' real estate portfolio is worth roughly $1.2 billion according to estimates by Morgan Stanley analyst Mark Wiltamuth. This will give either Walgreens or CVS instant dominance in one of the fastest-growing regions in the country and a destination for all those soon-to-be-retiring baby boomers.
Since mid-2007, it looks like Walgreens was actively courting Longs in the range of $62 to $65 a share before backing away on antitrust concerns. Due to store overlaps -- 63% of Longs' stores in northern California are within two miles of a Walgreens -- dozens of redundant locations would have to sold or closed to placate regulators.
Longs then approached CVS, which had just come off the successful acquisition of pharmacy benefit manager Caremark and was unencumbered by antitrust concerns. CVS stepped up with a $71.50 a share offer last month, worth nearly $2.7 billion, which was embraced by Longs' management as an easy way for shareholders to quickly realize the value of the company's land holdings. The deal has since been approved by the Federal Trade Commission.
Realizing its error, Walgreens fired back with a surprise $2.8 billion, $75 a share offer late last week. Longs' board of directors summarily rejected Walgreens' offer by saying they already had their chance, were spooked by regulatory risks, and were now just trying to cause a ruckus. Longs' largest shareholders are "irate" that the firm would turn down the extra cash and give seemingly unfounded preference to CVS -- which could have something to do with Longs CEO Warren Bryant snagging a big $24 million post-deal payday.
While Walgreens' true intentions remain unknown, it appears to be an attempt to sour the deal for CVS by forcing a higher counter-bid. Credit Suisse analyst Edward Kelly chimed in on the situation in a note to clients over the weekend, where he outlined a number of reasons why deal wouldn’t make much sense for Walgreens:
--Store closings outlined above would likely reduce deal synergies below the $100 million CVS expects in the first year.
--Less than 10% of Longs' locations are freestanding with a drive-though window compared to 80% of all Walgreens.
--Longs' average store size is double that of Walgreens, but similar to the Savon stores CVS recently acquired.
Longs' shares are trading near $75, a sign the market expects either Walgreens' bid to have a chance or for CVS to pony up and raise its offer. Walgreens is threatening to take the offer directly to Longs' shareholders. For their part, Advisory Research and Pershing Square, two major Longs shareholders, have refused to tender their shares to the CVS deal and are evaluating alternatives. CVS says it doesn’t intend to raise its offer.
On the surface, the deal appears rich, with Longs now trading at a price-to-book ratio of 3.15 versus 2.52 for Walgreens and 1.53 for CVS. But accounting rules undervalue Longs' real estate. A better metric is the price-to-sales multiple -- which stands at .50 for Longs, .55 for Walgreens, and .59 for CVS -- since the goal here is to achieve scale and quickly expand the store base.
(Disclosure: I don’t control a position in any of the companies mentioned)
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