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Nov 6, 2019

Walgreens' leveraged buyout seen as long shot by street

Don Lato discusses Walgreens

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Reports that Walgreens Boots Alliance Inc. is mulling what would be the biggest leveraged buyout in history were met with skepticism from Wall Street analysts who argued that the numbers simply didn’t add up.

Deutsche Bank argued that “it’s a great story until you do the math,” saying finance concerns would likely prevent a transaction. Analysts from Raymond James echoed the sentiment, saying the surprising development of going private is unlikely due to “the sheer size of the transaction, the lack of real estate ownership and the declining fundamentals.”

The pushback comes despite bullish bets over the last weeks that helped fuel the stock to close at the highest level since April on Tuesday. Shares were down 2.9 per cent in early trading on Wednesday. Still, analysts including those at Citi argued that while the chances of a leveraged buyout, known as an LBO, remain low, alternative options like some form of a breakup could be beneficial for investors.

Here’s a roundup of what analysts are saying:

Citi, Ralph Giacobbe

“While Walgreens certainly has characteristics that give some credence to an LBO,” such as low leverage, strong cash flow and a suppressed valuation, “the sheer size of a deal, the structural pressures the business faces, and years worth of cost reduction and financial engineering makes it somewhat difficult to envision.”

He said he wouldn’t be totally dismissive, however, with analysis implying a takeout could deliver returns in the low-to-mid teens despite a “hefty equity check” needed.

“We see lower probability of an LBO, and instead believe some sort of breakup as potentially more feasible in a strategic alternative scenario, although we debate the timing and value of those pieces at this point.”

Maintains neutral rating and US$60 price target.

RBC Capital Markets, Anton Hie

Going private would give the company time and latitude to find its path forward, however there are hurdles to that solution.

“Challenges, in combination with near-term headwinds, including a sluggish UK retail environment for its Boots UK subsidiary, are creating an urgency that has led WBA to take significant actions including its Transformational Cost Management Program, which seeks to generate at least $1.8 billion in savings to enable investments in future growth.”

Investors seem frustrated with the company’s slow progress and a lack of clarity on its strategic direction, which would be eased if it went private. “That being said, we believe any such deal would be challenging to structure and fund given the size of the enterprise.”

Maintains sector perform rating and US$58 price target.

Raymond James, John Ransom

“We think that the sheer size of the transaction, the lack of real estate ownership and the declining fundamentals argue against an LBO as the most likely scenario.” A quick “sanity check” using an LBO model indicates there could be a 13% internal rate of return at $67 a share, which assumes Ebitda declines reverse.

He highlighted that a roughly US$75 billion transaction would be almost twice the size of the largest LBO ever done, which implies private equity would need to raise about US$20 billion. That figure includes CEO Stefano Pessina rolling up his 16 per cent stake and the company selling down 50 per cent of its holdings in AmerisourceBergen Corp.

Rates the stock at market perform.

Deutsche Bank, George Hill

“We suspect WBA might be able to operate about 6x levered, implying (US)$54 billion in net debt and a ~(US)$16 billion+ equity check would be required to close a deal. While this is the basic math of the transaction, it ignores the challenges of the implied take private valuation for WBA’s shares (>8.5x EV/EBITDA), what the required exit multiple would need to be, and how a sponsor would generate a reasonable IRR (>15%) on the deal. We believe these realities will prevent a transaction from being consummated.”

Unattractive math and nature of the standalone pharmacy business are the biggest hurdles to a deal of this size. He would “expect to see a higher multiple paid by a strategic buyer that could extract more synergies, but one of those does not appear to exist for WBA.”

Rates shares at sell.