Thursday, March 21, 2013

Making Sense of ABC-Walgreens-Alliance Boots

Before the dust settles on the AmerisourceBergen / Walgreens / Alliance Boots news, let’s take a deeper look at the implications for drug channels. The Wall Street Journal’s Tim Martin and Jon Kamp did a very nice job of summarizing the basics in Deal Transforms Global Pill Pipeline.

In this longer-than-usual Drug Channels article, I probe:
  • How does Walgreen benefit?
  • What does ABC get?
  • What does this mean for drug procurement?
  • What should Cardinal do?
  • How will the companies balance competing priorities?
  • Will this become one mega-company?
Please add your own questions (and any answers!) in the comments below.

NOTE: I don’t address here how brand-name manufacturers should respond. If you are a brand-name manufacturer, email me to learn more.


Like any other major channel customer, Walgreens got a great deal by extracting a good chunk of ABC’s buy-side margins. (See below for the contract’s economics.)

By giving ABC its buying leverage for generics, Walgreens all but ensures the lowest cost of goods. (See below for more comments on the deal’s global buying platform.) If Walgreens chooses to do so, it will be well positioned to win the pharmacy industry’s race-to-the-bottom price war. See What Free Generic Lipitor Says about Pharmacy's Future.

An unusual aspect of this transaction is ABC’s offering up its equity to get a big distribution deal. But this should be seen as a potential win-win. Walgreen’s potential 23% equity stake in ABC helps ensure that contract savings flow to Walgreens. It also helps reassure ABC’s shareholders that Walgreens won’t grab every last penny.

Walgreens also gains the more robust distribution infrastructure of a major wholesaler, while gracefully backing away from its ill-conceived plan to insource purchasing of brand-name pharmaceuticals. The strategy was doomed by an inept rollout and an unnecessarily aggressive “sell direct or else” message. Manufacturers were justifiably concerned about Walgreen’s capabilities and the disruption to existing channel strategies. In its press release, Cardinal disclosed that 40% of its sales were shipped directly to a Walgreens pharmacy, further demonstrating Walgreen’s dependence on wholesalers.

There may be other benefits. Can Walgreens leverage ABC’s Good Neighbor Pharmacy Provider Network, the pharmacy services administrative organization (PSAO) that negotiates and administers contracts between PBMs and independent pharmacies?


Most obviously, ABC gains an unusually long, 10-year distribution contract with one of the two largest chain drugstores.

The deal’s profitability seems to fit the typical low-bid wholesaler strategy. Tom Gallucci of Lazard Capital estimates that ABC will earn EBIT margins of about 40 basis points on the new Walgreens’ business. In contrast, Cardinal’s total profitability from this volume was closer to 60 basis points, reflecting a blend of very low bulk warehouse margins and somewhat higher margins on the non-bulk, direct-store delivery business. See “EBIT Margins from Large Customers” (page 45) of the 2012–13 Economic Report on Pharmaceutical Wholesalers.

However, this analysis is simplistic, because ABC is also gaining “opportunities to accelerate the Company’s efforts to grow its specialty and manufacturer services businesses domestically and internationally (per its press release). In other words, Alliance Boots will be helping ABC expand its highly successful specialty businesses to Europe. I presume that ABC’s World Courier business will play a key role here, perhaps by aligning with Alliance Boots’ Alloga contract logistics business. This relationship, though hard to quantify, could turn out to the biggest win for ABC.

By the way, I expect ABC finally to bite the bullet and build a national redistribution center, akin to those operated by Cardinal and McKesson. Such a move will boost ABC’s margins on the deal, especially because ABC gets access to additional logistics fees from brand-name manufacturers. Until then, manufacturers will experience supply chain inefficiency by having to ship to ABC’s 24 regional distribution centers.


The deal creates a novel aggregation of cross-organizational, cross-border purchasing power. Vertical integration into generic manufacturing is nearly certain.

Walgreens is turning over its domestic generic purchasing to ABC, which gives it even more scale. ABC is getting a Generic Pharmaceuticals Purchasing Services Agreement from Walgreens Boots Alliance Development (WBAD), the Swiss joint venture formed in August by Walgreens and Alliance Boots.

Thus, ABC will now get to share in (and contribute to) the purchasing synergies of Walgreens and Alliance Boots. This part of the deal is crucial to ABC, because it can source products through WBAD for Walgreens stores along with all other wholesale customers. ABC can cancel the equity warrants if WBAD terminates the Generic Pharmaceuticals Purchasing Services Agreement. See section 5.1(d)(i) of the full agreement.

With generics on track to account for nearly 9 out 10 prescriptions within 5 years, buying power matters. I believe that a similar rationale drove the Express Scripts-Medco combination. And don’t forget that CVS Caremark claimed more than $700 million in total cost synergies in 2008 from their combination. (source) The majority of those savings came from generic drug purchasing—both sheer volume as well as contract comparisons (per CVS' Channel Power).

Given regional differences in drug formulations and packaging, these global synergies can be hard to access. The combination is likely to bypass traditional generic manufacturers and expand private label generic lines a la Alliance Boots’ Almus or McKesson’s NorthStar Rx.


My $0.02? Keep calm and carry on.

Cardinal still has three significant growth platforms: (1) Medical products (institutional and consumer), (2) Independent pharmacies (where Cardinal has successfully defended its Kinray share), and (3) China. Given the more fragmented structure of these markets, Cardinal’s earnings growth rate will likely improve. That’s the upside of reduced customer concentration and less pricing pressure from two mega-customers. See Mo Money, Mo Problems.

As Cardinal noted, it will get a “significant net working capital decrease” and “a meaningful net, after-tax benefit to cash flow from operating activities.” Translation: it will have lots of cash to reinvent the business.

I also think Cardinal will behave rationally and not try to grab McKesson’s Caremark contract. If McKesson also behaves rationally, we can expect an orderly CVS contract renewal. However, both Cardinal and McKesson will likely face a bigger margin hit than they would have if Walgreens hadn’t shifted its business. Hence, the Walgreen’s news was slightly positive for CVS Caremark’s stock. CVS Caremark may even have some new ideas on collaborative sourcing.

I’m sure Express Scripts is having second thoughts about its move to ABC. (See ABC Wins Express Scripts Contract from Cardinal.)  And I suspect that if Cardinal waits a few years (or less), Express Scripts will come back to Cardinal. Stay tuned.

There will surely be short-term pain and restructuring as Cardinal resizes its organization. But I believe that it will emerge as a stronger company.


For now, this transaction creates three companies with overlapping minority shares. As I told The Wall Street Journal: “The challenge is that it's now quite a complex organization, with many competing loyalties and agendas.”

A few examples:
  • After Walgreens becomes ABC’s major shareholder, will independents stay with ABC? If ABC loses the small customer, it will have traded the pleasure of higher-margin business for the thrill of lower-margin revenues. I suspect that ABC will retain most (95%+) of its smaller customers, but there will be friction and noise. Some pharmacy owners will whine, but ultimately price and service are what matter. If ABC can leverage its new scale into better pricing, then most pharmacy owners will stick with it. In the meantime, expect competing wholesalers to ramp up the counter-advertising.
  • ABC has successful, higher-margin consulting and outsourcing businesses that sell services to manufacturers. Will manufacturers continue to purchase these services, even as the combined organization tries to simultaneously squeeze manufacturer margins through global sourcing RFQs?
  • As the leading distributor of specialty medications to physician offices and clinics, ABC is heavily invested in the buy-and-bill channel. Meanwhile, Walgreens operates the largest home infusion business, which attempts to shifts administration out of physician offices. As the third-largest dispenser of specialty drugs, Walgreens also has a white-bagging program that undermines specialty distribution, per Specialty Pharmacies Keep Gaining on Buy-and-Bill.
In Walgreen+Alliance Boots: Questions about Global Pharmacy, I highlighted the elusive global synergies of retail pharmacy. The ABC angle just adds to the potential confusion. Are these management teams up to the tasks ahead? I'm not sure yet.


Short answer: Probably.

Walgreens has a 45% ownership in Alliance Boots, and is likely to exercise its 2016 option to own the whole business. Walgreens and Alliance Boots can buy up to 7% of ABC on the open market now, and has the option to own an additional 16% in 2016/17. Note that the agreement prevents WAG from owning more than 30% of ABC.

Assuming that small customers don’t desert ABC, I expect Walgreens/Alliance Boots to purchase ABC outright within 10 years. In Drug Channels' early days, I predicted that Alliance Boots would buy a wholesaler. (See 2006’s US Wholesalers Look to Europe and 2007’s The British are Coming?) Looks like I may end up being right about the outcome, but wrong about the timing…which is slightly better than just being wrong!

The transaction puts Stefano Pessina ever closer to his long-held goal of building a truly global organization. In 2017, Pessina will be 75 years old. He will also be the single largest shareholder of Walgreens, Alliance Boots, and (by extension), AmerisourceBergen.

Forbes recently pegged Pessina’s net worth at $6.4 billion. (source) The drug channels participants are all now playing on this billionaire’s chess board.


  1. Nice report Adam! Now to my indy friends..WAKE UP!! Your higher cost of goods supports ABCs ability to give your chain (WAG) and PBM (ESI) competitors a lower COG. If the Big 3 wholesalers successfully eliminate the competition in terms of independent wholesalers and ther co-ops, then indys are REALLY screwed. Mutual Drug, Value Drug, Rochester, Smith, Morris Dixon are among the few wholesalers that cater to independent pharmacy. If we lose them, we lose us. If you aren't buying from one of them, then you have the lost the right to whine.

    Too many people will bitch and moan about many things that are out of their
    control and they have no ability to change. Effecting the buy side
    dynamics is the one area we 23,000 store owners CAN effect and yet we
    choose not to. Don't like mail order? Stop buying from the wholesaler
    that supports it by charging us higher priced only to give that margin
    to them.

    Why won't our national associations say that? Because they take too much from them!

  2. A Little off topic.. but here you go..

    Discount Drug Plans for May Not Be Saving Medicare Money

  3. Adam - In your earlier post you concluded with the follow statement,
    "And from the department of Supply Chain Irony (SCI): By owning a chunk of ABC, Walgreens will now be heavily invested in the primary brand-name wholesale supplier to Express Scripts, Walgreen's least favorite PBM! Quite a
    tangled web for anyone trying to make sense of the drug channel."

    I would agree with you that Walgreen's if they want can use this relationship to pressure ESI from both sides, but the question is do they value the higher reimbursement rates they are currently getting from ESI or do you think they will scale back on that to position themselves as a lower margin but gaining back some of the volume they lost during the ESI spitting match? Would love to hear your thought in a deeper dive around this side of the equation.

  4. Adam,

    Well done and thanks for your insights. One thing is apparently clear - the Wholesale model proves to be incredibly efficient ! This move should not be an enormous surprise to anyone, including Independents. I encourage Independents to be considering the “WHY” behind a move like this and I’m not just referencing the economics, but the new healthcare landscape. Independents should consider investing in their teams, the culture they need to create as a differentiating factor and advancing the role of Pharmacy in such a manner that it feelsuncomfortable and disruptive and stretches their conventional practices.

    The business of Independent Pharmacy (from my observation) requires a shift from working “IN” this business to working “ON” the business. And, Independents should utilize speed and agility to shift and adapt to the as a strategic advantage –

    Two thing are certain, 1.) WAG is a DIRECT and INCREASINGLY growing competitor in direct competition with Independents 2.) It appears Stefano Pessina has read the book “Think and Grow Rich by Napoleon Hill and exercises the success, “What the mind of a man can conceive and believe, it can achieve”.

  5. My thoughts are that Walgreens can only achieve mega status
    with the transitional cooperation of Independent pharmacy, pharmacies that stay
    on board with the new ABC/Walgreens Corporation. Why Independent pharmacy would want Walgreens to become a mega company or why they would even want to do business with Walgreens is an enigma to me.
    Mr. John Davidson and Mr Dave Marley are correct.

  6. I find it interesting that no one has commented on the fact that they gave up almost 1/3 of their company for no real premium and what in essence amounts to growth opportunities which are yet to be clearly defined and purchasing synergies. They should have gotten a 20% premium on their stock at least for giving up a third, assuming a minority discount for lack of control. Instead, they got no premium and their stock has only jumped about 8%.
    Given the lack of any control premium, I see the deal as a vote of "no confidence" in their own ability to grow in international markets and take on sizable acquisitions for similar types of purchasing synergies. Walgreens and Alliance Boots now effectively will take the lead in their international growth strategy.
    Alliance Boots and Walgreens got a complete steal on the deal, and are not even given ABC the margin that they gave Cardinal.
    I fail to see how this deal was properly negotiated on behalf of ABC shareholders.

  7. Excellent analysis Adam (as always).
    Walgreens also seems to be ratcheting up its "unsolicited" offers to purchase indy pharmacies or their inventories. Maybe the issue of impact on independent pharmacies will be moot in a few years...
    In a more serious vein, any thoughts as to what point would a merger like this would start getting the attention of anti-trust regulators or is this type of upstream/downstream model less at-risk for such scrutiny?

  8. Adam, I am curious how Walgreens finally arrived that their quest for direct Brand Rx buying was a failure and did ABC conceive of this mega deal or was this a Walgreens idea?

  9. Adam - do you think that ABC created this idea or did Walgreens have to determine a plan B after failing to force the Brand Pharma companies to go direct? How long did it take them to figure the original plan would be a non-starter?

  10. Adam - What do you suspect happens to the "95%+" retention rate on small independents once WAG owns ABC and has access to competitive pharmacy data? Thanks for your thoughts.

  11. What if the WAG is not only looking to buy better on generics, save inventory carrying costs on brands......but actually figure out a way to "sell better"?

    Thus far, their PBM negotiation skills have been successful with small and mid level players. Their Rx selling prices with the big boys have been not much different than that of other PSAO's.

    Yet by owning a piece of ABC, they essentially have access to own a piece of the independent franchise program. By getting their foot in the door with ABC, they have the ability to consolidate PBM contracts under a new NCPDP chain #, which coincidentally could have double the numbers.

    If you give a moose a muffin....

  12. Since they are aggregating buying power, I don't see any major antitrust issues. The FTC is generally favorable to such combinations. See my comments on oligopsony in < a href=''>ESRX-MHS: Antitrust Issues (2 of 3).

  13. No idea. But I'm pretty sure they knew their buy-direct pitch had hit a wall.

  14. ABC has reportedly communicated that no
    information about other customers will be shared with Walgreens at any time.

  15. Perhaps. Above, I mention GNPPN, ABC's PSAO. However, both WAG and ABC have lots of work just for the basic supply/procurement agreement, so any attempted leverage with PBMs or payers can't really happen for a few years.

  16. What about if we assume that the equity + warrants arrangement is first leg of a full acquisition process... I am asking if (at some point) WAG owns ABC (and sharing or not sharing is impossible to monitor within one organization).. how will that impact the retention rate of the independent pharmacies? Thanks

  17. Ain't no rebates with generic manufacturers. The edge is dwindling and ABC's feeling this will help push their stock until biotech items start getting approved. Bergen knows generics will dominate from this summer until 2017 - so ... let WAG live the dream for 3.66 years. My only question is did I miss something in the Obamacare plan's writing which stated the FTC will no longer be able to regulate the actions of monopolistic healthcare companies? Because Obamacare is a huge part of the reason why these companies have decided to mesh. If 78% of reimbursement is standard and socialized - then they gotta get a better deal on procurement and lose the once-lucrative PBM deals.