KKR

Recent history says a $70B buyout could be bad news for Walgreens, KKR

December 12, 2019
When KKR formally approached Walgreens Boots Alliance about taking the retail drugstore chain private in early November, analysts were divided on whether it was a good idea for the PE shop to strike what would likely be the largest buyout of all time.

Now, a month later, it seems that lenders have listened to the naysayers. Last week, The Wall Street Journal reported that buyout talks between KKR and Walgreens had stalled after loan buyers pushed back over the terms, with the report adding that there doesn't appear to be an imminent deal. The biggest impediment: KKR and its prospective financiers reportedly couldn't come close to agreeing on the company's valuation, which analysts at Barron's have estimated could be between $75 and $80 per share, or roughly $70 billion.

And that deal-breaking disagreement ultimately could be a good thing for KKR.

For one, the firm has had mixed success with mega-deals throughout its history, with a failed 2005 investment in Toys R Us that led to roughly 33,000 job losses and a wave of criticism. And any deal for Walgreens would almost certainly be well above the roughly $45 billion take-private that KKR struck with TPG Capital and the buyout arm of Goldman Sachs in 2007 for Texas-based energy company TXU, in what's widely considered to be the largest leveraged buyout of all time. The TXU investment also ended disastrously, with the company filing for bankruptcy in 2014 after oil prices plummeted. It was one of a handful of mega-deals struck during the last late-stage economic cycle that turned out poorly for investors and companies alike. 

Five years later, lenders likely don't want to dole out a loan package that would be in the $50 billion range. And it's tough to blame them. The $1.2 trillion junk-rated leveraged loan market has been sputtering thanks to ultra-low interest rates. Consider: Loans for over 50 companies had lost at least 10 percentage points of value in the three months leading into October, according to Bloomberg. Some lenders in particular have reportedly grown impatient with investors that attained cheap debt for buyouts and dividend recapitalizations but failed to improve earnings in what's become a slowing economy. 

Even if lenders were on board, it's unclear if KKR alone could come up with necessary capital to strike a deal. Analysts have estimated it would take $20 billion to $25 billion in equity to reach an agreement. And KKR's latest flagship vehicle, KKR Americas XII Fund, is nowhere near that figure, having closed in 2017 on $13.9 billion. So it may require another private equity firm, sovereign wealth fund or institutional investor to chip in a significant chunk of money in a sort of club-style deal that has only recently begun to make a comeback. Either that, or KKR would have to find a few spare billions from its other investment strategies to make it happen. 

A Barron's analyst recently opined that Warren Buffett's Berkshire Hathaway could pitch in $10 billion toward the purchase price in hopes of the "elephant-sized" acquisition that Buffett himself has long sought. But the firm has had mixed results with PE in the past, notably when it teamed with 3G Capital to merge Kraft and Heinz to form Kraft Heinz in 2015, only to see the food and beverage conglomerate's stock lose more than 66% of its value since it peaked at $96.65 per share in 2017. To its credit, Berkshire has still banked dividend payments that have boosted its ROI, but Buffett's reputation as a nearly flawless dealmaker has still taken a hit. It's unclear if the 89-year-old would want to pair up with the industry again, especially given that earlier this year he accused firms of being dishonest in their earnings reports. 

It's clear that Walgreens is in need of a turnaround. Like many other retailers, the company has struggled due to the rise of ecommerce, facing increasing competition from the likes of Walmart and Amazon. But the company's bottom line has also suffered in part because of the decline in generic drug prices, as well as the rise of pharmacy-benefits managers that negotiate lower prices for drug makers and sellers, per The Wall Street Journal. Gone are the days when the likes of Walgreens and CVS could make up for dwindling convenience sales with a thriving pharmacy business. And partly as a result, Walgreen's stock has dropped nearly 40% since it hit its peak in 2015. 

As it happens, current Walgreens CEO Stefano Pessina has a history of striking it rich alongside KKR. He first teamed with the firm to take Boots Alliance private in 2007, then helped KKR earn a reported $7.3 billion in cash and stock when it sold to Walgreens in 2015, more than quadrupling its original investment. He later tried to lead a $9.4 billion acquisition of Rite Aid but was hindered by regulators, with Walgreens buying half the number of stores it originally intended to, for almost $4.4 billion. As of April, Pessina owned more than 15% of Walgreens stock, so he would again be in for a huge cash windfall to add to his substantial net worth if the company goes private. 

But ultimately, it may be a blessing for KKR if lenders walk away, especially given its history with massive club deals for a retail company in a late-cycle economic environment. 

Featured image via Mike Mozart/CC BY 2.0

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