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Walgreens Tumbles on Costly Global Deal (Update 1)

Updated to include CEO comments and additional analyst reactions.

NEW YORK ( TheStreet) -- Amid a contract standoff with competitor Express Scripts (ESRX - Get Report) and sales losses to CVS Caremark (CVS - Get Report) , Walgreens (WAG), the largest drugstore chain in the U.S., is hitting back after taking a 45% stake in European pharmacy giant Alliance Boots for $6.7 billion, in a cash and stock deal.

For Walgreens, the deal could transform the company into an international pharmacy powerhouse with a top presence in the U.S. and Europe, while giving it a growth and M&A strategy that differs from competitors Express Scripts and CVS Caremark who have scaled their U.S. presence through large deals in recent years.

However, analyst reactions and Walgreens tumbling shares signal that the company has to prove now is the time to invest in an international and European growth push, and that it can offset prospective market share losses in the fast-consolidating U.S. pharmacy industry.

With Alliance Boots, Walgreens will become one of the world's top drug store and pharmacies with over 11,000 stores in 12 countries, primarily in North America and Europe. For both companies, the deal fills a big strategic need; however, it comes at a big cost.

Walgreens will pay $4 billion in cash and $2.7 billion in its stock for a 45% stake in Alliance Boots and will have the option to buy a remaining 55% stake in Alliance Boots for $9.5 billion in coming years. That prospective $16.2 billion takeover valuation also comes with roughly $11 billion in Alliance Boots debt after its 2007 private equity buyout led by private equity giant KKR (KKR - Get Report).

Already, Walgreens has lined up $3.5 billion in bridge financing from Goldman Sachs and Bank of America Merrill Lynch to pay for the first leg of the deal.

Faced with a standoff on a $5 billion drug prescriptions contract with Express Scripts, and key customer losses to CVS Caremark, Tuesday's stake acquisition gives Walgreens a growth plan to counter quarterly sales losses. Meanwhile, Alliance Boots has found an entry into the U.S. after its chairman and part owner Stefano Pessina said that he would look for a "transformational" deal to turn the company from a European powerhouse into an international player.

The question is whether the timing of Walgreens bold international push and the strategy can add to the company's earnings, which may be hit by its Express Scripts standoff and customer losses.

"It is not surprising to see Walgreens pursue a substantial investment to mitigate the risk of lost Medco Health Solutions business and its limited opportunity to recover Express Scripts business," wrote Bank of America Merrill Lynch analyst Robert Willoughby, in a note to clients. Willoughby re-iterated an underperform rating on Walgreens and a $26 a share price target, citing continued U.S. market share losses to Express Scripts and CVS Caremark.

Walgreens said that the deal may add up to 27 cents to its diluted earnings per share after the deal closes, on an expected $150 million in annual cost savings and up to $1 billion in synergies through 2016.

In spite of a tough economy, Walgreens chief executive Gregory Wasson said the deal was done at "the right time," stressing that Alliance Boots generates the bulk of its revenue from stable European countries and that pharmacies historically perform well in a tough economy. Synergies will come from procurement and the introduction of Alliance Boots beauty brands to Walgreens stores, Wasson added.

"The synergy numbers are very real," says GAMCO Investors analyst Jeff Jonas, highlighting verticals like drug procurement and Boots' beauty products. Still, Jonas calls the deal "defensive" and says that, as a result, Walgreens paid a full price of roughly 10-to-11 times Alliance Boots' expected earnings.

"There is certainly no discount for Europe," says Jonas of the deal, adding that upside will hinge on continued double digit growth at Alliance Boots. "It's really execution at this point... and the global economy." Jonas adds that an alternative would have been for Walgreens to take a profit hit on a settlement with Express Scripts and use its cash to boost share buybacks.

Guggenheim Securities analyst John Heinbockel questions the timing of the EU push and cautions that the deal may not offset a prospective earnings loss if Express Scripts takes its existing Medco contracts, after their merger.

" We always thought that such expansion efforts would occur further down the line, be relatively modest in scale, and be initially centered on the faster growing Latin American markets," writes Heinbockel.

Walgreen also said it would increase its quarterly dividend to 27.5 cents per share from 22.5 cents.

In Tuesday trading, Walgreen shares tumbled nearly 6% to $30.09, near 52-week lows hit in pre-market trading. The Deerfield, Ill- based company's shares are off nearly 10% in 2012, underperforming double digit 2012 stock gains by Express Scripts and CVS Caremark.

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