FTC to examine tug of war for Longs

WALNUT CREEK, Calif .—Barring a successful takeover by Walgreens, it appears CVS Caremark holds the advantage in the tug of war for Longs Drugs.

As the Sept. 22 issue of Drug Store News went to press, the Longs acquisition had turned into a rollercoaster ride as Walgreens stepped forward in the 11th hour to attempt to upend CVS’ $2.9 billion bid for Longs’ 521 retail locations in California, Hawaii, Nevada and Arizona, as well as its debt and PBM services.

Looking to quash a takeover agreement Longs’ management already had approved with CVS, Walgreens unexpectedly stepped in with its unsolicited, non-binding bid to buy Longs for nearly $3 billion in cash and debt assumption, at the close of business Friday, Sept. 12.

As part of CVS’ deal, which is for $71.50 per share in cash, CVS would bolster its already strong PBM business by acquiring Longs’ Rx America subsidiary, which offers prescription benefits management services to more than 8 million members and prescription drug plan benefits to approximately 450,000 Medicare beneficiaries. Management plans to integrate Rx America with Caremark over time.

Longs’ executive team was quick to rebuff Walgreens’ bid—citing, among other concerns, inherent regulatory risks—and urged its stockholders to accept the tender offer by CVS.

In yet another late-breaking development, Longs indicated that it had received a request from the Federal Trade Commission seeking documents and information in connection with the Walgreens’ bid. According to Longs, the FTC is investigating whether Walgreens’ proposed acquisition of Longs “may substantially lessen competition among retail pharmacies in various portions of California, Nevada and Hawaii.”

The FTC also is seeking information regarding several markets that had not been examined in the FTC’s previous review of the proposed Longs-CVS deal, including Longs’ operations in Hawaii and Longs’ mail-order business. It is possible that the FTC may add to the request as its investigation progresses. Longs has stated that it is cooperating with the FTC.

Responding to news of the FTC investigation, CVS issued a statement that read: “The opening of an FTC investigation into the anticompetitive aspects of Walgreens’ proposed acquisition of Longs, coupled with such a burdensome request, is highly unusual at this stage, since no Hart-Scott-Rodino filing has yet been made. The related information request is as extensive as a Hart-Scott-Rodino second request and seeks information on 23 different geographic markets.”

“The FTC’s interest in this transaction is not surprising, since Walgreens has the second-largest number of pharmacy counters in Northern California (Longs has the most) and has announced plans to aggressively enter Hawaii (where Longs is, by far, the largest and strongest pharmacy operator),” the CVS statement continued.

“CVS believes this development underscores that a Walgreens transaction would entail significant antitrust-related completion risk and, at a minimum, would entail a regulatory review lasting well into 2009. Significantly, Walgreens previously terminated negotiations with Longs over antitrust concerns and has not offered to assume that risk for Longs’ shareholders. In addition, Walgreens’ nonbinding expression of interest is subject to completion of due diligence and lacks committed financing at a highly uncertain time in the economy and the financial markets,” the retailer added.

CVS also stated, “In contrast, the CVS Caremark transaction has cleared all regulatory hurdles, is fully financed and is ready to close. We continue to believe that the CVS Caremark offer is a compelling, certain proposition for Longs shareholders.”

On Sept. 5, the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act expired, satisfying a condition to the closing of CVS’ offer.

Also commenting on the development, Walgreens’ spokesman Michael Polzin said, “We have been working cooperatively with the FTC since the day we sent our original letter to Longs, and we are glad to see [the FTC] is moving forward on it. This is nothing unusual…the FTC is looking for the typical information to do [its] review.”

While Walgreens’ offer represents a $3.50 per share premium over the proposed CVS deal, the bid from Walgreens raised the eyebrows of many industry analysts, who cited the likely regulatory hurdles and substantial store divestitures that probably would prevent a Walgreens-Longs union in the end.

Walgreens’ management, however, is standing its ground and, as of press time, stated that it was prepared to take its message directly to Longs’ shareholders.

“Our proposal is compelling—it would deliver superior value to Longs stockholders relative to the CVS transaction and can be consummated without undue delay. We again request that we be given an opportunity to conduct customary due diligence pursuant to the terms of your agreement with CVS as soon as possible,” stated Jeff Rein, chairman and chief executive officer of Walgreens, in a letter to Warren Bryant, chairman, president and chief executive officer of Longs. “Although we would unquestionably prefer to work directly with you to complete a negotiated transaction, we are prepared to take our transaction directly to your stockholders.”

In response, Longs issued a statement that read, “As we indicated on Sept. 17, the Longs board of directors determined not to furnish information to, nor have discussions and negotiations with Walgreens. The Walgreens letter of Sept. 22 has no changes to its unsolicited, nonbinding expression of interest.”

Many industry observers also continue to view CVS as the logical buyer.

“We see significant antitrust issues in Walgreens’ proposed purchase of Longs, and Walgreens has limited the amount of regulatory risk it will bear,” stated Lehman Brothers analyst Meredith Adler in a recent research note. “By contrast, CVS has already received FTC approval and has a fully financed offer on the table which could close immediately.… If [the closing] takes longer, and we think it could, the current Walgreens offer is less than CVS’. We even see some risk that the deal gets blocked entirely.”

Commented Morgan Stanley analyst Mark Wiltamuth, “CVS could have the advantage in bidding for Longs as it does not face the problem of store divestitures” and has passed Hart-Scott-Rodino regulatory hurdles. According to Wiltamuth, in a letter to Longs, “Walgreens has set an upper limit of store divestures totaling up to 40 percent of Longs’ operating profit. We assume this would be a worst-case scenario, but it is indicative of the potential size of the divesture required.”

Credit Suisse analyst Edward Kelly noted, “The [Walgreens-Longs] transaction would result in combined market share greater than 50 percent in 20 of the 33 markets in which Longs operates. We estimate that the company could be required to divest up to 10 percent to 15 percent of Longs stores.” According to Kelly, those divestitures could reduce gross synergies of a potential Walgreens-Longs deal by $30 million to $40 million.

Meanwhile, CtW Investment Group—which manages investments for employee union pension groups, including many Longs shareholders—is calling on Longs’ board to establish a special committee for the purposes of holding an auction for the company. According to a letter sent in September to Mary Metz, chairperson of Longs’ governance and nominating committee, CtW said a special committee must, at minimum, retain an independent investment adviser, solicit offers from all interested parties and recommend the best offer to the board and shareholders.