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19-06-2012 18:52:00

3rd UPDATE: Walgreen to Spend $6.7 Billion on Alliance Boots Stake

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--Walgreen touts cost-savings and addition of Alliance Boots products in U.S. stores as key deal benefits

--Some are calling deal pricey and worry about exposure to Europe, which has weighed on retailers' results of late

--Walgreen's shares falling despite broader market rally, second-worst performer in the S&P 500

(Updates with details from Walgreen's conference calls, S&P ratings warning, additional background and the latest stock quote.)

By Sten Stovall and Melodie Warner

U.S. drug store owner Walgreen Co. (WAG) has agreed to buy a 45% stake in pharmacy-led health and beauty retailer Alliance Boots GmbH in a $6.7 billion cash-and-stock deal that will create the world's largest buyer of prescription drugs and will allow the company to consider expansion into emerging markets.

The deal also marks the first step toward what will be the biggest exit from a leveraged buyout for owners Kohlberg Kravis Roberts & Co. (KKR.XX) and Alliance Boots Chairman Stefano Pessina, which took the former FTSE-100 retailer private for GBP11.02 billion in 2007, amid high hopes and grand plans for growth.

But the economic turmoil seen since 2008 hit those ambitions hard. The company's latest full-year results showed it is still struggling with a debt mountain of some GBP7 billion amid an ongoing consumer downturn that threatens to deepen.

The news sent Walgreen's shares down 6.4% to $29.93 in recent trading, making it the second-worst performer in the S&P 500 behind fellow retailer J.C. Penney Co. (JCP). Though Walgreen has touted cost-savings and the addition of Alliance Boots products in the company's U.S. stores, some are calling the deal pricey and exposure to Europe--which Walgreen gains with this deal--has weighed on retailers' results of late.

Tuesday's deal will see Walgreen initially invest about $4 billion in cash and 83.4 million shares for a 45% minority stake in Alliance Boots, owner of Europe's biggest pharmacy chain, a transaction that will give KKR back almost all of its investment in the retailer.

The U.S. buyout firm invested GBP1.2 billion in Europe's largest-ever leveraged buyout deal and will receive GBP1.2 billion back, though the exchange rate has affected KKR's return. In 2007, GBP1.2 billion cost the firm's funds $2.45 billion but is now only worth $1.8 billion, meaning KKR currently stands to make 2.2-times its money on the investment, although this is 2.7-times its money in pounds.

Mr. Pessina also put in about GBP1.2 billion and has made very similar returns to KKR, according to a person close to the deal, but he will hold most of it in Walgreen shares. Co-investors also invested a further GBP1.2 billion alongside KKR and have had a similar amount (about GBP1.2 billion) of cash returned, the person added. The total amount of equity in the deal is GBP2.6 billion, with a further GBP1.7 billion of stock.

Walgreen will have the option to buy the remaining stake in about three years for approximately $9.5 billion in cash and stock, plus the assumption of Alliance Boots then-outstanding debt.

Chief Executive Greg Wasson said Walgreen has "every intention" of completing the final stage of the deal which will leave Walgreen as a prescription drugs behemoth which combines the two retailers' fire power, generates economies of scale to cut costs, fuels growth and geographic expansion.

Walgreen expects the deal to add between 23 cents to 27 cents to adjusted earnings in the first year.

If approved by regulators, the deal would be the largest in Walgreen's history and comes on the heels of a handful of smaller acquisitions, including the purchases of New York drugstore chain Duane Reade and online retailer Drugstore.com Inc.

Walgreen executives told analysts the planned transaction wasn't in response to its rate dispute with pharmacy-benefits manager Express Scripts Holding Co. (ESRX) that has hurt sales this year. Chief Financial Officer Wade Miquelon said the deal had been in the works for more than a year, adding a company of Walgreen's size "is not going to do a transformational transaction of this magnitude unless you're thinking about the strategic fit, the overall financials and the very-long haul."

Though the Alliance Boots investment should help fill an earnings hole near-term given Walgreen's deterioration in same-store sales this year tied to the spat with Express Scripts, some argue that it could also mean Walgreen is less likely to settle with Express Scripts in the near term. There had been speculation Walgreen would be pushed into making a deal with the PBM as customers went elsewhere to fill their prescriptions, though that chatter may get squashed as Walgreen focuses on the large transaction.

Earlier Tuesday, Walgreen reported an 11% drop in fiscal third-quarter earnings to $537 million, or 62 cents a share, down from $603 million, or 65 cents, a year earlier. Sales dropped 3.4% to $17.75 billion.

Walgreen also raised its quarterly dividend by 22% but said stock buybacks were being put on hold amid the Alliance Boots deal. The company has spent $1.2 billion on repurchasing shares so far this fiscal year.

The deal's structure, as well as Walgreen's shift away from conservative financial policies, led Standard & Poor's Ratings Services to put the company's investment-grade rating on watch for downgrade. Though S&P's rating on Walgreen currently stands at A, the company could face a three-notch cut to triple-B if the deal is completed as planned.

Write to Sten Stovall at Sten.Stovall@DowJones.com

--John Kell of Dow Jones Newswires and Paul Hodkinson of Private Equity News contributed to this article.

(END) Dow Jones Newswires

June 19, 2012 12:52 ET (16:52 GMT)

Copyright (c) 2012 Dow Jones & Company, Inc.

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