Cartoonist Rube Goldberg designed fantastical machines to complete simple tasks through tortuously convoluted mechanisms. Buyout shop Sycamore Partners might take his contraptions as a model, judging by a Wall Street Journal report that it’s in talks to acquire Walgreens Boots Alliance. The struggling $8 bln drugstore is buried under a $36 billion morass of debt, leases and legal costs. Yet a carefully orchestrated clean-up might extract a salvageable asset.

The idea is straightforward enough. Set aside the complications and focus on Walgreens’ net debt of $6.4 billion. On that basis, before deal news broke on Tuesday, it traded at under 4 times estimated EBITDA for the fiscal year ending in August, according to LSEG data. In 2019, private equity firm KKR and Walgreens’ Executive Chairman Stefano Pessina explored a take-private at a sum approaching $90 billion, including debt. A deal has gotten much, much cheaper since then.

Problem is, Walgreens carries $23.3 billion of lease liabilities and a $6.6 billion burden related to settled litigation over opioid prescriptions. Operating income is set to decline by one-third, to $1.7 billion, making it harder to bear substantial buyout debt. A buyer might need a chunky equity check.

For Sycamore, that makes lightening the balance sheet imperative. After all, assume it pays a 20% premium, or some $9 billion, for Walgreens’ shares while taking on $10 billion of leverage. Ignoring the leases and legal costs, if it exits at the same multiple in five years while keeping growth steady, its annualized return would be 21%, Breakingviews calculates.

The issue is clearing away the complications. There may be flexibility around leases. Walgreens already plans 1,200 store closures. But many of its landlords are individual investors, and some leases roll over to single-year renewals after a while, according to consulting group Foresite Commercial Real Estate. Ruthless negotiations may cram down rents.

The required cash could also be reduced. Pessina could roll over his 17% stake, or even angle to carve out the group’s UK drugstore Boots. Walgreens’ international unit might be worth $4 billion, according to Morgan Stanley.

None of this changes the fact that the business is being squeezed by health insurers on the pharmacy side and giants like Walmart in retail. That’s a big part of why shares have tumbled 75% in five years. Sycamore might nonetheless be willing to go through these contortions anyway because it’s just cheap enough now to be worth it. But turning theory into practice isn’t as easy as sketching it out on paper.

Context News

Walgreens Boots Alliance is in talks to sell itself to private equity firm Sycamore Partners, the Wall Street Journal reported on Dec. 10. In 2019, KKR and Walgreens Executive Chairman Stefano Pessina mulled taking the company private. The drugstore chain’s market capitalization was $55 billion at the time. Walgreens’ market capitalization stood at $7.4 billion at the close of trading on Dec. 9.

More By This Author: