LONDON/NEW YORK (Reuters) - U.S. drugstore chain Walgreen Co WAG.N is taking a 45 percent stake in European health and beauty group Alliance Boots Holdings Ltd ABN.UL for $6.7 billion in cash and stock, making a surprisingly big bet on Europe in the midst of the euro crisis.
The move will create the world's biggest buyer of prescription drugs and give both companies reach into new markets. But Walgreen shares were down 6 percent as some investors were concerned by the decision to expand in Europe.
The deal, the result of talks that began 18 months ago, marks Walgreen's first move beyond its home market and will give it more clout with drugmakers at a time it is losing sales because it no longer fills prescriptions for members of a major pharmacy benefits manager, Express Scripts Holding Co (ESRX.O).
Analysts were surprised by the nature and scope of the deal given that Walgreen had never made international expansion a priority.
"You're betting the entire company, " said Jeff Jonas, analyst at Gabelli & Co. "I think if their old strategy had been working well, they'd be in the Express Scripts network and using most of their cash to buy back stock."
Standard & Poor's warned that the $3.5 billion in debt Walgreen will take on for the deal "will result in a meaningful deterioration of Walgreen's financial risk profile."
Walgreen will pay $4 billion in cash and 83.4 million of its shares for the stake. The retailer also raised its dividend by 22.2 percent on Tuesday and reported quarterly earnings.
Walgreen stands to benefit from Boots' growing presence in emerging markets including China. It also plans to sell popular Boots brands like No. 7 and Soltan, giving Boots the entree into the U.S. market it has sought for 10 years.
A combination would create a business with more than 11,000 stores in 12 countries and more than 370 distribution centers delivering to more than 170,000 pharmacies, doctors, health centers and hospitals in 21 countries.
Walgreen's finance chief, Wade Miquelon, said total sales could top $130 billion in fiscal 2016. Last year, Walgreen had sales of $72 billion, while Boots had revenue of 23 billion British pounds ($36 billion.)
If Walgreen decides to exercise its takeover option in three years, it will pay $4.9 billion in cash and issue 144.3 million shares for the remaining equity. It will also assume Alliance Boots' outstanding debt, which was just over 7 billion pounds at its 2011-12 year-end.
BIG PAYDAY FOR KKR
Alliance Boots was formed by the 2006 merger of Boots, a fixture on British main streets, and Alliance UniChem, a pan-European wholesale and retail pharmacy group owned by executive chairman Stefano Pessina and private equity firm KKR & Co LP (KKR.N).
The ability to grow was a reason for the deal rather than taking Alliance Boots public through an initial offering, Pessina said during a conference call.
"If you do an IPO, you create financial value. If you do a transformational deal, you create financial value and industrial value, and you have a lot of synergies," he said.
But both companies said they had no plans for job reductions.
KKR bought Alliance Boots in 2007 for 11 billion pounds at the height of the private equity bubble, sealing the largest buyout in Europe - a record that stands today.
Should Walgreen follow through with its plan to buy the remainder of the company, KKR stands to earn 2.7 times its initial investment, a person familiar with the situation said - a very good return under current market conditions.
Walgreen said the deal, which will put four of its senior executives on the Alliance Boots board, is expected to help net earnings by 23 to 27 cents per diluted share in the first year following completion.
Combined synergies across both companies were forecast between $100 million and $150 million in the first year and $1 billion by the end of 2016.
Walgreen's U.S. retail business has suffered since January, when it stopped filling prescriptions for members of Express Scripts, which manages prescription drug benefits for employers and other clients. The two companies had failed to renew their contract.
In the quarter ended May 31, sales at Walgreen drugstores open at least a year slipped 6.6 percent. Prescriptions sales in comparable stores fell 9.9 percent. Having fewer people come in to pick up a prescription and go instead to rivals CVS Caremark Corp (CVS.N) and Rite Aid Corp (RAD.N) also hurt sales of general merchandise.
The fight with Express Scripts hit Walgreen's earnings per share by 6 cents during the quarter.
Walgreen President and Chief Executive Gregory Wasson sought to reassure investors the company still expects U.S. growth.
"It is certainly not a 'hail Mary,'" Wasson said of the deal, using a term for a desperation play in American football. "We are as bullish on our U.S. business as we have ever been."
Walgreen will maintain its existing headquarters in Deerfield, Illinois, while Alliance Boots is committed to current support offices across Europe and keeping its operational hub in Nottingham, England, where John Boot established the British half of the business in 1849.
Separately on Tuesday, Walgreen reported third-quarter earnings of $537 million, or 62 cents per share, compared with $603 million, or 65 cents per share, a year earlier.
Excluding costs from the Alliance Boots deal, Walgreen earned 63 cents per share. Analysts, on average, expected earnings of 62 cents, according to Thomson Reuters I/B/E/S.
Walgreen shares were down 5.9 percent at $30.07 on Tuesday afternoon on the New York Stock Exchange. (1 British pound = $1.57)