WAG Buys Cystic Fibrosis Stake

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To negate the impact of the initial contract loss with Express Scripts Holding Company (ESRX) as well as to win back former Express Scripts clients and stimulate customers’ demand amidst a challenging macroeconomic scenario, drug retailer Walgreen Co. (WAG) has been taking a number of strategic steps. Following a gigantic $6.7 billion merger with a global international pharmacy-led health and beauty group, Alliance Boots, and the acquisition of a regional drug pharmacy chain, this leading drug retailer recently formed a new alliance with Cystic Fibrosis Foundation in order to penetrate the specialty pharmacy market that holds high growth potential.

This new partnership deal will get Walgreen a significant ownership stake in the parent company of Cystic Fibrosis Services, Inc., a specialty pharmacy providing medications and treatment for cystic fibrosis, a severe genetic disease. This disease causes acute lung infections and premature death. Financial terms of the deal were not disclosed. However, even after this deal is closed, Cystic Fibrosis Services will continue to operate under its present name through its existing location in Bethesda, Maryland.

Cystic fibrosis is currently spreading at an alarming rate. According to recent data, 30,000 adults and children in the U.S. and 70,000 people globally are suffering from this killer disease. Further, data shows that 10 million people in the U.S. (one in 30) carry the defective cystic fibrosis gene which reflects a huge growth opportunity in the future market as well. Walgreen, with its 7,900 stores (including 180 hospital outpatient pharmacies), is optimistic about offering its value added services to this patient population who are members of the Cystic Fibrosis community.

The Express Scripts contract loss remained a major hitch for the company since the beginning of 2012 as the contract had contributed a significant part of its sales (12.6% of total prescriptions filled in August 2011). Although, in July, Walgreen and Express Scripts entered into a new multi-year pharmacy network agreement, Walgreen’s ability to win-back its previous customers remains a concern. The company operates in a fiercely competitive market with players like Rite Aid Corporation (RAD) and CVS Caremark Corporation (CVS).

As a result, Walgreen is currently concentrating on several partnerships, acquisitions and strategic steps to drive growth.  In August this year, the company entered into a partnership with Alliance Boots GmbH, in which it acquired a 45% stake for $6.7 billion. The company also has the option to attain 100% ownership over the next three years for an approximate value of $9.5 billion in cash and stock.

In September 2012, Walgreen launched a complete customer loyalty program ‘Balance Rewards' which claims to be the largest consumer loyalty program in the U.S. In the same month, the company completed its acquisition of a mid-South U.S.-based regional drugstore chain from Stephen L. LaFrance Holdings Inc. for $438 million. We expect these new ventures to boost growth going forward. Nevertheless, it remains to be seen if these measures can neutralize the headwinds related to the Express Scripts contract.

Currently, Walgreen retains a Zacks #3 Rank (short-term Hold rating). We have a ‘Neutral’ recommendation on the stock over the long term.

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