Walgreen (WAG) PX14A6G Letter to shareholders

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 Vote Against Approval of Issuance of Shares (Item 2)

to CompleteAcquisition of Alliance Boots

at December 29, 2014 Special Meeting

of Walgreen Shareholders

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CEO Wasson out, AB’s Pessina in! What Just Happened?

• 2 weeks before vote Wasson suddenly announces intent to stepdown, with no successor in place and no clear succession planannounced.

• AB’s Pessina will assume interim-CEO position.

• Two chief architects of this deal from WAG’s side now gone:CFO Miquelon and CEO Wasson.

• After 2.5 years of partnership and promises of smooth merger,shareholders are to vote with no idea who will lead thechallenging integration.

• Where was the board during this coup? It has remained silent, asit did during this deal’s other twists and turns.

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Paying for the privilege of being taken over.

• An original deal, not even billed as a ‘merger of equals,’ but anacquisition with a control premium, now grants AB control overWAG’s operations plus a takeover premium.

• The “blended management team” is now dominated by AllianceBoots executives.

• If WAG’s management needed overhauling, there are cheaperways to do this than a $24 billion deal.

• History has repeated itself. Pessina used the 2005 mergerbetween his company, Alliance UniChem, and the Boots Groupto gain control of the combined company.

• Sets up specter of competing power bases - Nottingham,Chicago

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Why vote AGAINST the full takeover of AB?

• Unnecessary –The existing partnership and joint venturealready achieve most, if not all, realizable synergies. There islittle need for the $24 billion second step.

• Overvalued –The premium is exceedingly rich and providesvaluation multiples far above comparables.

• Strategically risky –Shareholders face heightened exposure tounderperforming AB business amid weak Euro markets.

• Poorly negotiated –The cost of the acquisition has risen 28%since announced, investor vote delayed 2+ years.

• Lacks credible execution –Management has reducedcombined FY2016 EBIT 20% and has failed to give shareholdersneeded disclosure.

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Alliance Boots:Looking under the hood shows sand in its growth engine

• Majority owned by Stefano Pessina and KKR
• AB is primarily a European drug wholesaler
  –Source of revenue:

             Europe > 90% of total
             Wholesaling = 67% of total

• Limited organic growth potential:Retail pharmacy chains are prohibitedin most of Europe, making vertical integration impossible.
• Flat sales for the foreseeable future:The firm faces shrinking drugspends in many of its primary wholesaling markets, and increased retailcompetition in the UK. In 2013, wholesale profits were down and retailsales were flat.
• Global growth platform untested:AB’s investments in China and LatinAmerican are new, small and risky.

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Deal Overview:Selected Timeline of Walgreen’s Complex and Unstable Transaction

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Deal Overview:The unusual two-step business combination failed to give investors timely vote

Transaction	Date	Deal Term	Consideration	Governance
Joint venture,	Aug 2012	“Step 1”	$4.0B cash	Pessina & Murphy
equity swap			83.4 M shares	(KKR) join WAG’s
(45% stake in				board; hold 7.7% and
AB)				~0.7% respectively
Full Acquisition	Pending	“Step 2”	$4.9B cash	~16 to 20% ownership
			144 M shares	Pessina Exec Vice
			(AB’s Debt)	Chair

 

		2012 Projections			2014 Realities
2016 operating profit	$	9 - $9.5B		$	7.2	B
Combined debt	$	11	B	$	17.9	B
Total cost of deal	$	28.9	B	$	35.7	B
EV/EBITDA (2015)		11.5	x		14.8	x
AB’s annual operating		9	%		4.4	%
income growth

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Deal Overview:
Market reaction to deal ambivalent

Walgreen’s share price has benefitted from a bull market, and has tracked a similar trajectory to close competitor CVS since the transaction was announced.

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Acquisition Unnecessary: Paying for Pessina’s Empire Building, not for Synergies

Synergies to date are procurement from purchasing JV.
o	Probably a “majority” of procurement synergies can occur without second-step, according to Walgreen CFO.
Top two competitors have opted for the capital lightapproach of procurement joint ventures.

     o      CVS JV with Cardinal

     o      Rite Aid JV with McKesson  

• WAG has similar deal with AmerisourceBergen & AB- a betterway to test the waters of global consolidation.

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Acquisition Overvalued: Excessive premium the road to buyer’s remorse

• Debt plus equity of second step ~$24 bn

• Consideration offers up to a 93% premium above fair value of AB’sequity under second step.

• Buffett’s first law of capital allocation: “what is smart at one price isdumb at another”

WAG is Paying EV/EBITDA Forward Multiple for13 

Step 2 Far in Excess ofComparables

Mid-point valuations of fairness opinions provided by Goldman Sachs and Lazard compared to second step transaction cost based on consideration valued at $13.96 billion (based on Aug. 11. 2014) and expected debt.

          WAG is Paying up to a 93% Premium for Remaining Equity of AB                  14

                                                                                   OVERVALUED:  COST OF STEP 2 EQUITY

                                                  Blue = Cost to WAG shareholders           Red = Goldman Sachs          Green = Lazard

Due to AB’s privately-held status, the premium over and above market value is not available from per-share data. Using the midpoint valuations performed by Lazard andGoldman Sachs pursuant to the three valuation methodologies, we illustrate the takeout premiums using a second-step consideration value of $13.96 billion (based on Aug. 11. 2014 valuation date).

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The Deal is Risky:Threats to Alliance Boots Performance and Synergies

Continuing Headwinds from Europe
	Austerity policies driving down drug prices, set to remain in place.
Timing, Likelihood of Synergies Uncertain
	Procurement synergies are back-loaded.
	Top-line synergies promised but appear unlikely.

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The Deal is Risky:Doubtful beauty synergies make deal look even uglier

Boots’ beauty strategy faces challenges in US
	Differences in US and UK markets make importing Boots’ beauty success unlikely.
	US customers resist drugstores for beauty, favor high-end specialty retailers.
Margins are slashed for Boots products in US
	Boots products cost up to 55 percent less at Walgreen.

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The Deal is Risky:The long line of British failure in America

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Acquisition poorly negotiated:Benefits AB’s Sellers

• Issue up to 25% in undervalued stock currencywithout“ceiling”protection for WAG shareholders on two-year option;

• Yetconcede downside “floor” protection for AB holders.

WAG Historical EV/EBITDA Trading

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Acquisition poorly negotiated:Long-term

shareholdervoices effectively silenced

Failed to protect shareholder franchise by:
o	Avoiding shareholder vote for 2 years:
	o	Shareholders should have more say…“The way WAG has structured [this deal] treats shareholders very poorly…Shareholders have no real say… since the minimum purchase price ...is essentially set now even though there is no shareholder vote”      - Barclays Equity Research, 20 June 2012

    o No provision for a vote of the disinterested shares in Second Step, when Pessina already holds 7% of voting shares  

• Failure to establish independent committee to renegotiate priceas AB’s performance slips and risk increases.

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Lacks Credible Execution:Acquisition comes at time of strategic missteps and internal acrimony.

WAG shocked market with $2 billion forecast reduction in August; 20% reduction in FY2016 EBIT goal for AB/WAG, stemming from:
	Internal miscalculation of generic pricing and Medicare Part D reimbursement rates
	Underperformance in both AB and WAG’s core businessÏAB growing at half the rate expected in 2012
Controversy over the departure of CFO and other top-ranking executives
Increasing pressure from hedge funds to prop up stock:
	Undertake a tax inversion
	Pursue share buybacks

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Lacks Credible Execution:Disclosure leaves shareholders in dark on critical issues

• How well the board negotiated, oversaw original 2012agreement and its decision to proceed without key dealprovisions, shareholder vote.
• The basis of the original financial fairness opinions in 2012 andthe extent to which they would have supported what is now amore expensive deal for a weaker performing business.
• The degree to which hedge funds engaged and influenced theboard and/or key management, and the board’s decision toacquiesce to short-term activist demands.

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Jana settlement further clouds interests of long-term shareholders

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Summary: Why vote AGAINST this deal?

• Unnecessary
• Overvalued
• Strategically Risky
• Poorly negotiated
• Lacks credible execution

Appendix

Trend to Procurement Joint Ventures