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How the World's Biggest Leveraged Buyout Could Be Done

Chris Hughes

(Bloomberg Opinion) -- The mooted record-breaking leveraged buyout of Walgreens Boots Alliance Inc. is a reminder of the powerful role of private capital in modern finance. But the fact that a private equity owner has a chance at making decent returns even after paying a premium for the U.S. pharmacist raises difficult questions. Might the public markets be missing something yet again?

A deal for Walgreens would be massive even without a takeover premium. But assume a bidder must pay a proper top-up — say, 20%-30% — and things get really ambitious. That would imply an offer of $85 billion, including assumed net borrowings. The debt component could be about $48 billion on LBO-style leverage multiples, with an equity part of $37 billion. Even with chief executive officer Stefano Pessina rolling over his 16% stake into the new entity, the private equity firms would still have to find close to $30 billion assuming there are no associated disposals.

To get there would require more than just a consortium deal. The private equity firms involved would have to call on additional support from their fund investors to support this specific buyout. But such arrangements do exist, and there is a real possibility of putting together such a syndicate to contribute the huge equity commitment. The private capital markets are deep.

Now consider the potential gains. To make a deal stack up, the private equity firms would want at least a 15% internal rate of return. This is plausible. Analysts at Credit Suisse Group reckon a Walgreens LBO could generate such an outcome with a bid at a 20% premium that uses debt worth fives times Ebitda. In fact, the drugstore chain could plausibly take its leverage as high as six times Ebitda. On that basis, Citi analysts reckon private equity buyers could clear the 15% returns hurdle by 2025 while paying $77 a share for Walgreens, a 29% premium.

It’s not as if the assumptions involved in such modeling are especially racy. Credit Suisse forecasts $11 billion of Ebitda after five years of private equity ownership, with revenues increasing at 3.5% per year. That’s not much more bullish than the consensus analyst forecasts for Walgreens’ near-term sales. Ebitda margins would need to recover to 6.7%. Walgreens achieved that in 2018.

In summary, an LBO is a stretch but it could stack up. As ever with a buyout, there are two enablers: the leverage, and the relatively depressed valuation of Walgreens on the stock market. The company may need some restructuring, which tends to result in big upfront charges and losses followed by a period of earnings volatility. Public share prices don’t like that. Moreover, Walgreens has been caught up in the general fear about the health care sector and the disruptive forces hitting retail such as Amazon.com Inc. Might stock market group-think have pushed that too far?

A possible Walgreens megadeal may just be top-of-the-market recklessness. But long-term investors should remember that Pessina knows the value of this business better than anyone, and private equity firms see their job as snapping up mis-priced assets.

To contact the author of this story: Chris Hughes at chughes89@bloomberg.net

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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