A June Deutsche Bank report estimated that a tax inversion could save WAG nearly $1 billion in taxes by 2018, increasing EPS by about 15%.Despite political opposition, WAG management has begun to seriously consider a tax inversion. Though he had previously dismissed the idea, CEO Greg Wasson stated on the company's most recent conference call that the board is actively evaluating the tax structure of the second-step transaction among other "opportunities below the operating [income] line." On the same call, management pulled its previously announced fiscal 2016 operating earnings, cash flow, and net debt targets for the combined company. WAG performance had been running below target earnings, though it was on track to meet the latter two goals. Analysts initially expressed concern that WAG might be backing away from its previous optimism about the transaction, but management indicated that they remain confident and plan to release new guidance that better reflects the combined company's capital structure. In my opinion, this is clear evidence that management plans to restructure the second step of the transaction and pursue a tax inversion. With 240,000 employees, WAG is a large employer sensitive to political issues. Pursuing a tax inversion is far from a certainty, but I believe management's commentary suggests that it is the most likely outcome. Irrespective of the political consequences, the earnings boost would be a clear boon to shareholders. So, what does all this mean for the Hedged Value portfolio, which holds a long position in Walgreen? Despite my expectation that WAG will ultimately undergo a tax inversion, that is not why I own it. An inversion could still be derailed by Congress or internal opposition. I own WAG because I believe the quality of its retail franchise and its earnings power in combination with Alliance Boots are underappreciated by the market and not fully reflected in its current valuation. Through its purchasing consortium with Alliance Boots and AmerisourceBergen (ABC), WAG is the largest generics buyer in the world. The company may realize significant benefits from reshaping the global pharmaceutical supply chain, continuing to improve the in-store experience, and expanding internationally. While the successful completion of the merger with Alliance Boots and continued smooth integration of the two companies is an important part of the investment thesis, my investment is not predicated on a tax inversion.
One of the perennial challenges of investing with a long time horizon is deciding what to do - if anything - when near-term events independent of the long-term thesis may influence a holding's share price. WAG presents just such a challenge today. To what extent might other investors' expectation of an inversion already be reflected in the share price?If management decides not to heed activists' recommendations, might they choose to sell and place downward pressure on the share price? Conversely, if a tax inversion is successful, might the share price rise to reflect the increased earnings of the company? Ultimately, these considerations are secondary to valuation. I believe WAG already trades below the fair value of its earnings power, even without an inversion. If management decides not to pursue an inversion and the share price declines, that could present a buying opportunity. If the inversion takes place, I would view it as a nice bonus. As a result, Cable Car has not adjusted its position in WAG. We will find out soon — management plans to announce the updated transaction details in late July or August. Photo credit: Phillip via Flickr Creative Commons To learn more about Covestor, contact our Client Advisers at firstname.lastname@example.org or 1.866.825.3005. Or you can try Covestor's services with a free trial account. DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
The post What Walgreen’s tax-inversion move means for investors appeared first on Smarter Investing Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to http://covestor.com or contact Covestor Client Services at (866) 825-3005, x703.