Thursday, September 24, 2015

Why Walgreens Boots Alliance is Triggering a Huge AmerisourceBergen Stock Buyback

On Tuesday, AmerisourceBergen announced a new $2.4 billion share repurchase program. Read the press release. This new program brings ABC’s total repurchases to more than $4 billion in less than two years.

Here's why: ABC’s multi-faceted deal with Walgreen Boots Alliance (WBA) is motivating these transactions.

Let’s peer over the hedge and find out what’s going on.

A BUSTLE IN YOUR HEDGEROW

In March 2013, AmerisourceBergen announced a unique set of agreements with Walgreens and Alliance Boots—the two companies that merged to form Walgreen Boots Alliance (WBA).

Under one crucial element of the deal, Walgreens Boots Alliance has the right (but not the obligation) to acquire up to a 23% ownership stake in ABC. Under certain circumstances, they also have an option to buy an additional 5% of ABC’s stock.

Initially, WBA can acquire a combined 19.9 million shares of ABC’s shares on the open market, which would equal about 7% of ABC’s outstanding common stock (assuming full exercise of the warrants). As of May 2015, Walgreens had acquired 11.5 million of these shares, which was equivalent to 5.2% of ABC’s outstanding common stock. WBA’s cumulative cost basis for the shares acquired was $717 million, as of May 31, 2015. Thus, WBA acquired its open market ABC share at an average cost of $62.35 per share.

ABC also granted equity warrants to Walgreens Boots Alliance. The warrants are exercisable in 2016 and 2017 for an additional 45.4 million shares. Assuming full exercise of these warrants, Walgreens Boots Alliance would collectively own an additional 16% of ABC’s outstanding common stock.

The 2016 WBA warrants have an exercise price of $51.50 and a total cost of $1.2 billion. At ABC’s current stock price of almost $103, the value of the 2016 warrants is more than $2.3 billion, or almost $1.2 billion above the exercise price. WBA's profit on its 2017 warrants, which have an exercise price of $52.50, is almost as big. Sweet.

If ABC’s stock falls below $51.50 during the six-month period beginning in March 2016, then Walgreens Boots Alliance can acquire an additional 14.2 million shares. That would equal an incremental 5% of ABC’s outstanding common stock, assuming full exercise of the warrants. Unless ABC’s stock collapses, it’s unlikely that WBA will be able to acquire these additional shares.

The agreement prevents WBA from owning more than 30% of ABC. Walgreens Boots Alliance will have the opportunity to add two directors to ABC’s board of directors. In January 2015, Ornella Barra, a Walgreens Boots Alliance executive who runs its global retail and wholesale business, joined ABC’s board. She replaced Greg Wasson, formerly Walgreens’ president and CEO.

FYI, Ms. Barra has her very own hagiographic website at http://www.ornellabarra.com/. It’s really quite astounding and worth visiting.

HEDGE HO

ABC has been hedging its shareholders’ exposure to the ownership dilution from the WBA warrants.

By issuing warrants to WBA, ABC will increase its share count and therefore reduce the amount of earnings associated with a single share. ABC is hedging this dilutive effect by (1) purchasing its own shares and (2) buying options to purchase shares.

If ABC was fully hedged, then it would have enough offsetting shares to retire the shares it will issue when WBA exercises its warrants. Since May 2014, ABC has spent $1.65 billion buying back its own shares and buying call options. The 2016 warrants are fully hedged and 2017 warrants are less than 50% hedged.

The new $2.4 billion program announced on Tuesday will bring the total to over $4 billion. ABC can fund this activity with cash flow and borrowing. But don’t be surprised if ABC asks for more money or better terms during your next negotiation.

Historically, wholesalers have used operating cash flow primarily for share buyback programs. Stock buybacks are generally a tax-efficient means of returning cash to shareholders. Dividends are taxable, but there is no tax due on a share buyback unless investors sell their shares. By reducing the number of outstanding shares, buybacks increase Earnings per Share (EPS) growth. But in this case, ABC is buying shares back to prevent a drop in EPS once WBA executes its warrants.

Is this a good deal? I like how George Hill at Deutsche Bank summed up the situation:
”We believe WBA may have cut the better deal initially, but ABC has been unusually shrewd with its hedging strategies. As ABC’s stock price has about doubled since the deal was announced, debating who got the better deal may be a moot point to ABC or WBA equity holders.”
So, there's no need to be a Mr. Pricklepants. It looks like ABC got good advice from Wall Street.

I’ll put ABC's actions into further context in our new 2015-16 Economic Report on Pharmaceutical Wholesalers and Specialty Distributors, which will be available by October 6.  In the meantime, please enjoy these 16 fun facts about hedgehogs. (BTW: Why don't they just share the hedge?)

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