U.S. Securities and Exchange Commission
Washington, DC 20549
NOTICE OF EXEMPT SOLICITATION
1. Name of the Registrant:
WALGREEN CO.
___________________________________________________________________________
2. Name of the person relying on exemption:
CTW INVESTMENT GROUP
___________________________________________________________________________
3. Address of the person relying on exemption:
1900 L STREET, NW, SUITE 900 WASHINGTON, DC 20036
___________________________________________________________________________
4. Written materials. Attach written materials required to be submitted
pursuant to Rule 14a6(g)(1):
CtW INVESTMENT GROUP
RE: VOTE AGAINST PROPOSED MERGER WITH ALLIANCE BOOTS AT WALGREEN CO.'S
(NYSE: WAG) SPECIAL MEETING ON DECEMBER 29, 2014.
December 3, 2014
Dear Walgreen Co. Shareholder:
On December 29, you will be asked to approve the unnecessary, overvalued and
risky takeover of Alliance Boots. With the bulk of the tangible, low-hanging
synergies already realizable from the 2012 joint venture agreement between
the two companies, the board fails to make a compelling case for investing an
additional $24 billion to fully acquire Alliance Boots.
Specifically, the deal is:
* Unnecessary: Walgreen's executives have acknowledged that most - if
not all - of the potential benefits from the full acquisition could be
realized on the basis of the existing partnership.
* Overvalued: Walgreen is overpaying for Alliance Boots by at least 10%
and up to 20%; the fairness opinions provided by Walgreen's financial
advisors, as well as our own analysis, show that Walgreen's
shareholders will be paying an implied transaction value of $35.7
billion for a company that would be fairly priced at approximately
$30 billion, including all synergies.
* Risky: Walgreen is assuming that Alliance Boots will meet Walgreen's
expectations for its future growth, which it has not done over the
past two years, and Alliance Boots currently faces an increasingly
unfavorable environment in its main European markets.
* Poorly negotiated: The deal results from a poorly executed negotiation
process which failed to protect the interests of long-term Walgreen
shareholders, and unnecessarily deferred shareholder approval for more
than two years following the initial merger announcement.
* Lacking in credible execution and disclosure: The deal presumes
effective execution and transparent disclosure from a management team
and board that in August dramatically reduced the key profit
targets of the combined company, refused to disclose information
pertinent to that miss, and may have improperly shared material inside
information with select investors.
In other words, Walgreen shareholders are being asked to vote in favor of a
high-cost, high-risk transaction that substantially dilutes their control
over the company, with Alliance Boots' owners achieving more than a 16% stake
in Walgreen, even though the full acquisition may be unnecessary to
realizing the promised returns.
ACCORDINGLY, WE BELIEVE YOU HAVE POWERFUL REASONS TO VOTE AGAINST APPROVAL OF
THE ISSUANCE OF SHARES TO COMPLETE THE ACQUISITION (ITEM 2) AT THE SPECIAL
MEETING OF SHAREHOLDERS ON DECEMBER 29.
The CtW Investment Group works with union-sponsored pension funds in order to
enhance long-term shareholder value through active ownership. These funds
have over $250 billion in assets under management and are substantial
Walgreen shareholders.
ACQUISITION IS UNNECESSARY: MOST SYNERGIES ATTAINABLE WITHOUT SECOND
STEP
The unusual, two-step structure of the Alliance Boot ("AB") acquisition has
lent the deal a degree of inevitability, and the company frequently addresses
the transaction as if it is a fait accompli. In August 2012, Walgreen
purchased a 45% stake in AB along with the option to acquire the rest of the
company 30 months later, the subject of the special meeting on December 29.
The companies subsequently established
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202-721-6060
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2
a procurement joint venture in Switzerland to achieve economies of scale in
purchasing drugs, consumer goods, and other items.
Critically, this joint venture, which added AmerisourceBergen to its roster
in 2013, offers the only concrete synergies articulated in the AB deal -
namely purchasing synergies. Walgreen executives have acknowledged that these
purchasing synergies could be achieved without the full acquisition of AB. At
an analyst conference in January 2013, former CFO Wade Miquelon stated that
Walgreen could get "a significant, a majority, probably" of the procurement
synergies without step two of the deal, and Divisional Vice President of
Investor Relations Rick Hans confirmed that "the JV is already approaching
vendors as a combined buying entity . . . it's a combined buying group right
now."/1/ Mr. Hans had previously suggested during an investor presentation
that the purchasing synergies would be realized whether or not the second
step is completed./2/
RATHER THAN TREAT THE ACQUISITION AS A FAIT ACCOMPLI, SHAREHOLDERS HAVE THE
OPPORTUNITY TO MAINTAIN THE STATUS QUO, WHICH WOULD PRESERVE THE BULK OF THE
PROMISED SYNERGIES WHILE AVOIDING A $24 BILLION OUTLAY THAT WILL MASSIVELY
INCREASE WALGREEN'S LEVERAGE AND EXPOSE IT TO A HOST OF NEW RISKS.
ACQUISITION IS OVERVALUED: VALUATION EXERCISES SUGGEST IT IS OVERPRICED
BY 10 TO 20 PERCENT
IT IS CLEAR FROM OUR OWN ANALYSIS AND THE VALUATION EXERCISES CONDUCTED BY
WALGREEN'S FINANCIAL ADVISORS THAT THE COST OF COMPLETING THE ACQUISITION
SUBSTANTIALLY EXCEEDS THE STAND-ALONE VALUE OF AB. CONSEQUENTLY, THE
ATTRACTIVENESS OF THE DEAL TO CURRENT WALGREEN SHAREHOLDERS DEPENDS
CRITICALLY ON THE EXPECTED SYNERGIES AND THEIR DISTRIBUTION BETWEEN WALGREEN
AND AB SHAREHOLDERS.
First, consider the cost of the transaction to Walgreen shareholders. Table 1
breaks out the cash and share components of the second step, the cost for the
second step depending on the share price used, and the implied overall cost
of the AB acquisition for Walgreen's shareholders:
TABLE 1: COST OF CONSIDERATION AND TOTAL TRANSACTION TO WALGREEN SHAREHOLDERS
($BILLIONS EXCEPT SHARE AND RATIO DATA)
Period $ Cash WAG # of Value of Step 2 Total Cost Implied
Implied
Share shares WAG Consid- of Step 2 EV of AB
Forward
Price shares eration (incl $10.3
EV/EDITDA
AB debt)
Multiple
Vol. Wgt. $5.01 $52.59 144,333,468 $7.59 $12.60 $22.90 $33.32
13.8
~2 Yr. Avg./3/
Valuation
Date (Aug.
11, 2014) $5.01 $61.99 144,333,468 $8.95 $13.96 $24.26 $35.68
14.8
YTD Vol.
Wgt. Avg./4/ $5.01 $64.89 144,333,468 $9.37 $14.38 $24.68 $36.44
15.1
The range of share prices included in Table 1 overlaps with, but is generally
lower than, the range of prices used by Walgreen's financial advisor Goldman
Sachs ("GS") in the fairness opinion provided to Walgreen's board. We believe
that these share prices provide a fair but conservative basis for evaluating
this complex transaction. Based on these calculations, we find that Walgreen
shareholders are being asked to pay AB shareholders between $12.6 and $14.3
billion to complete the second step--or roughly $24 billion, including the
cost of AB's $10.3 billion in debt.
____________________
/1/ Walgreen Co.'s Analyst Q&A Conference transcript, January 10, 2013.
/2/ Lazard Capital Markets Investor presentation, November 13, 2012.
/3/ July 20, 2012 (announced settlement date with Express Scripts) to
October 31, 2014.
/4/ Through October 31, 2014.
3
Walgreen's financial advisors GS and Lazard provide illustrative valuations
of AB as a standalone company based on comparable public company trading
multiples, the enterprise value to EBITDA multiples characterizing comparable
past transactions, and discounted cash flow (DCF) analysis of projected
financial performance provided by Walgreen's management:
TABLE 2A: MID-POINT VALUATIONS OF AB FROM GOLDMAN SACHS ($BILLIONS, EXCEPT RATIO DATA)
Method Midpoint EV Midpoint Midpoint Valuation
EV/EBDITA of 2nd step
Multiple
Comparable Companies $23.4 9.8 $7.2
Precedent Transactions $26.2 11.5 $8.8
DCF (Standalone) $24.8 9.9 $8.0
TABLE 2B: MID-POINT VALUATIONS OF AB FROM LAZARD ($BILLIONS, EXCEPT RATIO DATA)
Method Midpoint EV Midpoint Midpoint Valuation
EV/EBDITA of 2nd step
Multiple
Comparable Companies $22.3 8.9 $6.6
Precedent Transactions $26.6 10.6 $9.0
DCF (Standalone) $28.4 11.4 $10.0
Bear in mind that while comparisons to other drug retailers or wholesalers
and the DCF analysis provide a "stand alone"valuation for AB, the precedent
transactions presumably took place at valuations which reflected the expected
synergies from the various mergers and acquisitions GS and Lazard reviewed. Note
that the multiple implied by GS' transactions-based valuation is well
above those of the other methods it employed, and Lazard's is well above that
of its comparable companies analysis./5/
With the exception of Lazard's outlier DCF analysis, taking the midpoint of
the midpoints provided by the other methods it and Goldman Sachs employ
suggests that AB on a standalone basis would have an enterprise value around
$25 billion, implying a $15 billion equity value and $8 billion standalone
value for a 55% equity stake. Walgreen shareholders are being asked to pay
substantially more than this, nearly $6 billion more based on the valuation
date pricing shown in the second row of Table 1.
This $6 billion acquisition premium would be justified if, in addition to
there being few risks to the financial projections for the stand-alone
company, the projected synergies are at least three times this premium. The
Boston Consulting Group has reported that "in successful deals, acquirers do
not give more than one-third of estimated synergies to the target shareholders
in the form of acquisition premiums."/6/ Table 3 shows the estimated value of
the synergies according to GS and Lazard, along with the maximum acquisition
premium consistent with no more than one-third of those synergies being captured
by AB:
TABLE 3: ESTIMATED SYNERGIES AND ACQUISITION PREMIUM IF 1/3 OF SYNERGIES
WENT TO AB SHAREHOLDERS ($BILLIONS)
Advisor Low End MidPoint High End
Estimate 33% to AB Estimate 33% to AB 33% to AB
Goldman Sachs $12.1 $4.0 $14.2 $4.7 $16.2 $ 5.4
GS minus Clawback $11.4 $3.8 $13.5 $4.4 $15.5 $ 5.1
Lazard $12.4 $4.1 $22.5 $7.4 $32.6 $10.8
>/S>
____________________
/5/ Furthermore, the transaction multiples for pharmaceutical wholesalers, the
segment that comprises 70% of Alliance Boot's revenue, have fallen sharply since
the 2008 financial crisis: from an average multiple of 13.8x to just 9.2x,
implying a substantial deterioration in the growth prospects of this industry.
/6/ Jens Kengelbach, et al., "Divide and Conquer: How Successful M&A Deals Split
the Synergies" Boston Consulting Group & Technische Universitat Munchen, March
2013, pg. 2.
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4
We note that once again, Lazard's estimates are well above those of GS, and also
that GS includes in its estimate the value of the clawback (3% of AB's equity or
about $750 million) that Walgreen would owe AB if the merger were not completed
other than as a result of rejection by Walgreen shareholders.
Table 4 summarizes the total cost of completing the second step of the merger to
Walgreen shareholders, including the assumption of $10.3 billion in AB debt, as
compared to a "fair price" in which no more than one-third of projected
synergies accrue to AB in the form of an acquisition premium:
TABLE 4: HOW OVERPRICED IS THE SECOND STEP? ($BILLIONS)
Advisor Stand Alone AB 33% of Fair Trans- Actual Trans- Excess Excess %
Synergies action value action value Premium
Goldman Sachs $25.00 $4.69 $29.69 $35.68 $6.00 17%
Lazard $25.00 $7.43 $32.43 $35.68 $3.26 9%
Consequently, the premium appears to be too high and the division of benefits
between Walgreen and AB shareholders appears unfair, even based on the analysis
of financial advisors who have every reason to describe this transaction as
positively as possible. In addition to the excessive price tag, the synergies
anticipated by management are subject to substantial risks, making it far from
certain that the combined company will be able to achieve the performance goals
used in the fairness opinions valuing AB.
ACQUISITION IS RISKY: THREATS TO AB PERFORMANCE AND SYNERGIES
THERE ARE CLEAR REASONS TO BE SKEPTICAL OF THE PROJECTED SYNERGIES, THE FUTURE
PERFORMANCE OF AB, AND THE LIKELIHOOD THAT THESE COMPANIES CAN BE INTEGRATED
SMOOTHLY.
Walgreen has already experienced a significant set-back with respect to its
projection for FY2016 operating income, originally announced in conjunction with
the AB deal in June 2012: Walgreen had initially anticipated operating income of
$9 to $9.5 billion for the combined company (including procurement synergies),
but it has now had to lower that projection to $7.2 billion./7/ While there were
apparently multiple reasons for this miss, including management's failure to
properly anticipate increased prices for certain generic drugs, AB's performance
to date has not met Walgreen's expectations when it proposed the two-step
transaction in 2012. Walgreen's initial projection assumed annual growth in
operating income at AB of about 9% from 2012 to 2016, according to a recent
Barclay's report, but to date its annual growth has been 4.4%. Barclays
attributes one-third of the earnings miss to AB's underperformance./8/
TIMING, LIKELIHOOD OF SYNERGIES UNCERTAIN
The projected synergies from this transaction are substantially back loaded:
more than two-thirds of the present value calculated by Walgreen's financial
advisors represents gains from after FY2018, and more than one-third of the
pre-2018 synergies are supposed to be realized in FY2018 itself. On this point,
Cantor Fitzgerald has written that Walgreen's current guidance for the combined
company "would imply very aggressive, back-end loaded growth relative to FY16
objectives."/9/ While Walgreen's managers have suggested that other benefits
will accrue to shareholders, for instance, from applying "best practices" to
the design of store formats or from the sale of Boots beauty products in the US,
these gains seem especially speculative. Walgreen currently provides a very
different product mix than AB, suggesting that the importation of new store
formats could be very challenging. Additionally, AB has had to substantially
mark down the prices of its beauty products in the US.
____________________
/7/ Michael Siconolfi, "Walgreen Shakeup Followed Bad Projection" Wall Street
Journal August 19, 2014
/8/ Meredith Adler, Sean Kras, and Eric Percher, "Walgreen Co." Barclays
Capital, September 22, 2014 pg. 4.
/9/ Ajay Jain, "No Near-Term Relief on Pharmacy Margin Pressures" Cantor
Fitzgerald, October 1, 2014.
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5
CONTINUING HEADWINDS FROM EUROPE
The overall economic trajectory of the major European countries where AB
operates, including the continued application of austerity measures to health
care spending, creates serious headwinds for the company. A report we recently
commissioned from the Austrian Health Institute on European pharmaceutical
pricing policies lays out these trends in detail, and it concludes that these
austerity policies - such as reductions in wholesaler margins and changes in
reference pricing formulas - have reduced drug spending by about 3% a year since
2009./10/ Similarly, Business Monitor International has projected that
pharmaceutical spending growth in AB's key markets will be negative or only
slightly above zero in the near future./11/ In part for these reasons, analysts
at Deutsche Bank Securities have written that "we estimate that both the
Walgreens and AB earnings will deteriorate in F2015 . . which prompts us to
question the underlying strength of the respective businesses,"/12/ while
analysts at Credit Suisse have argued that "[t]he core underlying U.S. business
is clearly challenged, Europe lacks organic growth, and below the line
initiatives are not exciting enough in our view. In fact, we would not be
surprised if questions around the merits of the AB deal arise once again given
the eventual valuation, the fact that many of the benefits could have been had
through partnerships, and its secondary revenue synergy focus./13/
UNCHARTED TERRITORY FOR WALGREEN
Finally, it is worth noting that up until Greg Wasson became CEO in 2009,
Walgreen had become the second largest US drug retailer almost entirely through
organic growth. The company has limited experience integrating acquisitions,
and is now undertaking not only a major integration project, but one whose
international scope is far outside the company's prior experience. Cantor
Fitzgerald has stated that "[t]he recent trajectory of financial performance of
Walgreen and AB has been disappointing and the combined operations could
generate integration challenges and negative synergies. Walgreen's
management has little direct experience with international operations."/14/ In
order to support the approval of the second step, shareholders would have to
believe that despite this lack of experience both with large-scale corporate
integration and with international operations, Walgreen's management will be
able to complete this undertaking with essentially no further disappointments.
ACQUISITION WAS POORLY NEGOTIATED
FROM ITS INCEPTION, THIS TRANSACTION HAS BEEN PURSUED BY WALGREEN'S MANAGEMENT
AND BOARD IN A MANNER THAT HAS UNDULY AND UNNECESSARILY ATTENUATED SHAREHOLDER
INFLUENCE AND ACCOUNTABILITY.
The decision to divide the transaction into two steps, whatever its possible
justifications, deprived shareholders of the ability to approve or disapprove
of the AB merger at the outset; shareholders instead are only able to decide if
the second step of the transaction should be completed for consideration
negotiated over two years ago. Given what Walgreen management describes as a
significant degree of integration between the companies since the adoption of
the first step, the two-step process has made the eventual complete merger of
the companies appear to be a fait accompli, whether or not Walgreen's
shareholders would have approved the proposed transaction had they been given
vote in 2012.
Moreover, Walgreen's management and board failed to negotiate terms that were
in the interests of Walgreen shareholders. For instance, while the merger
agreement provides a floor for the total value of
____________________
/10/ Sabine Vogler and Katharina Habimana, "Pharmaceutical pricing policies in
European countries" Gesundheit Osterreich Forschungs- und Planungs GmbH, October
2014.
/11/ Business Monitor International country reports, released September 26
2014, for Germany, France, Spain, Italy, and the UK.
/12/ George Hill and Stephen Hagan, "Under Pressure: WAG F4Q Results and
Lackluster Outlook" Deutsche Bank Markets Research, October 2, 2014, pg. 3.
/13/ Edward J. Kelly, Judah C. Frommer, and Lauren Wood, "Updated Guidance a
Major Disappointment as Management Overpromises and Under delivers" Credit
Suisse, August 6, 2014.
/14/ Ajay Jain, "No Near-Term Relief on Pharmacy Margin Pressures" Cantor
Fitzgerald, October 1, 2014.
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6
shares to be issued to AB's shareholders, protecting them against a decline in
Walgreen's share price, it contains no ceiling to protect Walgreen shareholders
from overpaying as a result of appreciation in the company's share price. Such
a provision would likely have resulted in a much lower cost for Walgreen
shareholders and a more attractive proposition. Moreover, at the time the
two-step transaction was first announced in 2012 Walgreen was trading at
approximately 14% below its median value over the prior five years and 35% below
its peak value immediately prior to the Express Scripts conflict. Given the
negative impact of this conflict, the fact that Walgreen announced its
resolution only one month after announcing the merger, and the reasonable
expectation that this resolution would have a significant and positive effect
on Walgreen's share price, the board's failure to secure a ceiling on the value
of the consideration to be paid by Walgreen shareholders seems inexplicable.
ACQUISITION COMES AT TIME OF SIGNIFICANT INTERNAL CHALLENGES
RECENT DEVELOPMENTS AT WALGREEN DO NOT GIVE US CONFIDENCE THAT EITHER THE
ONGOING INTEGRATION IS PROCEEDING ACCORDING TO PLAN OR THAT WALGREEN'S
MANAGEMENT IS CAPABLE OF SUCCESSFULLY INTEGRATING THE COMPANIES.
Current management's account of the revisions to projected FY2016 operating
income emphasizes its own failure to anticipate or effectively manage price
spikes for generic drugs and compressed Medicare Part D margins, both of which
Walgreen's competitors appear to have handled much more smoothly, as well as
inadequate communication between key internal departments. Nor are we reassured
by the addition of JANA Partners' Barry Rosenstein to the board: while Mr.
Rosenstein has led a number of successful activist engagements, these have
generally been on a very short time horizon (our analysis finds JANA exits
rom its public targets within a year of initiating a position), and Mr.
Rosenstein himself does not appear to bring either corporate integration,
retail, or international operating experience to the board. While we support
opening the board to direct shareholder participation, we believe that the
appropriate way to do so would be through adoption of the proxy access proposal
which received support from half of non-insider Walgreen shareholders at the
last annual meeting.
SUMMARY: AN UNNECESSARY, OVERVALUED AND RISKY ACQUISITION
Walgreen's shareholders have every reason to oppose the second step of the AB
merger. They are paying an excessive premium even assuming that the company's
projected performance targets, including synergies, are achieved. This prospect
that looks increasingly dim as the reality of both Walgreen's and AB's current
performance becomes clear. Worse still, the successful integration of these
companies rests in the hands of an executive team with little relevant
experience and a recent track record of embarrassing errors.
Instead, WE URGE WALGREEN SHAREHOLDERS VOTE AGAINST APPROVAL OF THE ISSUANCE OF
SHARES TO COMPLETE THE ACQUISITION (ITEM 2) AT THE SPECIAL MEETING OF
SHAREHOLDERS ON DECEMBER 29, AND TO URGE THE BOARD TO ENGAGE CONSTRUCTIVELY
WITH LONG-TERM SHAREHOLDERS.
For more information please contact Michael Pryce-Jones at 202-721-6079 or
visit www.ctwinvestmentgroup.com/walgreen.
Sincerely,
/s/
Dieter Waizenegger
Executive Director
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