It's a Dot-Com Drug Deal Gone Bad

Medicated Americans complaining about hefty prescription costs in this country can take heart. Sometimes the pharmacy chains have to pay up, too.

Walgreen (NYSE: WAG  ) is paying $3.80 a share for drugstore.com (Nasdaq: DSCM  ) , a whopping 113% premium to where the dot-com laggard closed yesterday.

Do you think Walgreen could've gotten drugstore.com cheaper in Canada?

The $409 million transaction is going to turn heads. You have to go back nearly 11 years -- to the sudsier side of the dot-com bubble -- to find the last time that drugstore.com was trading in the double digits. It also closed yesterday mere pocket change from its 52-week low.

The fundamentals justify the pessimism before this morning's bailout. The Web-based retailer has missed Wall Street's profit targets in three of its past four quarters, posting losses in five of the past six quarters.

If Walgreen was in a bidding war a hefty premium would make sense, but who would it be up against? Rival pharmacies? Rite Aid's (NYSE: RAD  ) debt-shackled balance sheet wouldn't allow it to raise a bidding card. CVS Caremark (NYSE: CVS  ) is still grappling with the Caremark prescription benefits management business, a niche that Walgreen is in the process of unloading.

Wal-Mart (NYSE: WMT  ) and Amazon.com (Nasdaq: AMZN  ) would make more sense as potential gentlemen callers, but they're not the type to go berserk on the front porch. Wal-Mart has a thriving pharmacy business and ambitious dot-com aspirations, but the "everyday low prices" discounter's DNA wouldn't allow it to overpay. Amazon has been chummy with drugstore.com in the past, but it's already selling just about everything through its organically expanding virtual storefront.

I get it. Walgreen's move away from managing prescriptions and last year's Duane Reade acquisition signal a push back to retail. Why not overlook the iffy margins of a dot-com retailer for the sake of brisk existing sales and a killer generic domain name. Walgreen also posted a reasonable quarterly report this week that wasn't enough to please the market. If investors want more sizzle out of Walgreen, this morning's glitzy buy is one way to get there.

I'm just left wondering if it really had to pay that much and why corporate ambulance-chasing attorneys have the gall to argue that drugstore.com's board is actually selling itself cheap.

Do you think that Walgreen is overpaying for drugstore.com? Share your thoughts in the comment box below.

Wal-Mart Stores is a Motley Fool Inside Value choice. Amazon.com is a Motley Fool Stock Advisor recommendation. Wal-Mart Stores is a Motley Fool Global Gains pick. Motley Fool Options has recommended a diagonal call position on Wal-Mart Stores. The Fool owns shares of Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Rick Munarriz thinks it's been about a decade since he placed an order with drugstore.com. He does not own shares in any of the stocks in this article. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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  • Report this Comment On March 24, 2011, at 1:24 PM, leelinch wrote:

    Last year, Amazon paid 500 million to buy Quidsi. Quidsi ran the the websites Diapers.com and Soap.com. Doing a search using my Google Analytics account, I noted that "diapers.com" and "soap.com" were searched an average of 168,100 times per month.

    Walgreens just offered to buy Drugstore.com for 429 million. Doing a search using my Google Analytics account, I noted that "drugstore.com" and "beauty.com" were searched an average of 261,500 times per month.

    Walgreens just paid 14% less for a company getting 55% more hits.

  • Report this Comment On March 24, 2011, at 1:56 PM, TMFBreakerRick wrote:

    leelinch, I hear you, but there's more to this than just search engine queries. There's a reason why Amazon.com is worth more than Buy.com.

    For starters, Wal-Mart was also reportedly bidding for Quidsi last year. The Diapers.com and Soap.com sites are also sticky sites built for repeat purchases at regular intervals, something that drugstore.com is not (though it could be, one would think).

    I also don't recall Quidsi financials being made public so I can't get into profitability vs. drugstore.com's lack of profitability, but I do recall reading that Quidsi was growing quickly -- a lot faster than drugstore.com.

    I just don't think you pay more than 200% of what Mr. Market thinks a company is worth unless it's imperative to own. Walgreen did not NEED drugstore.com this badly.

  • Report this Comment On March 26, 2011, at 4:24 PM, leelinch wrote:

    Walgreens bought Drugstore.com because they wanted to get it on the cheap before anyone else did. It really is that simple.

    Some things to consider:

    1. DSCM was trading only .31 above its 52-wk low. It had received an extra haircut the past few weeks as some mandatory dumping came into the stock when it was announced they would be removed from the NASDAQ Internet Index. The price WAG should offered to pay for DSCM was not much different than DSCM's 52-wk high.

    2. DSCM, though in business for over a decade, was only now (IMO) starting to get traction and scale up. I didn't even know who they were till about 6 months ago after doing a Google search for air filters for my humidifier. Guess who had the lowest price: DSCM... lower than AMZN and lower than could be found on EBAY. Then, weeks ago, I learned my wife had starting buying skin cream from them... at the recommendation of one of her friends.

    3. Eyeballs and Fans. Despite being a dwarf compared to AMZN, did you know on facebook that DSCM has 1/3 as many fans as AMZN?

    4. Discovery Equity Partners (a hedge fund) had been buying DSCM stock like a kid buying chocolate in a candy store. They had recently accumulated a 10%+ position and were still buying. Last September Discovery made an offer for to buy out TESS @ 15.50/share after accumulating a 13.8% position.

    The fact DSCM just got bought out does not surprise me nor did the $3.80 offer price. Had WAG offered much less, they would have been inviting a rival bid from AMZN and/or Discovery and possibly someone else we are not even aware of. WAG is hoping that by offering $3.80/share that they will keep the other suitors at bay.

    The only people not happy with the offer price are the nearly dozen law firms now claiming that a doubling of the DSCM stock price was still not enough. I only agree with them on one point... I do believe if DSCM has been left to its own devices, that it once again could have returned to a double-digit stock price by the end of the decade.

    IMO, WAG got a good deal.

  • Report this Comment On March 27, 2011, at 11:58 PM, ctyank99 wrote:

    Rite Aid does have debt. Anyone that follows Rite Aid knows that. That's their biggest challange. The rest of their financial picture is looking brighter, though. They've had three months of increased same store sales. They cloed "loser" stores. They've relocated stores and build some beautiful new stores.

    Rite Aid reported a growth of 1% in same-store sales for the five weeks ended February 26, 2011.

    For the month of February, Rite Aid's front-end same-store sales increased 1.1%. Results moderated from an increase of 2.2% in January 2011.

    Pharmacy same-store sales in February improved 0.9% despite a 243 basis point headwind from new generic introductions. Results improved from a 0.6% increase in January 2011. Prescriptions filled at comparable stores increased 1.3%.

    Total drugstore sales improved 0.1% year over year to $2.438 billion for February 2011. In the five-week period, Prescription revenue contributed 68% of drugstore sales while third party prescription revenue accounted for 96.4% of pharmacy sales.

    Cash flow is not an issue.

    This is all great news as far as I'm concerned. I've been buying RAD and I'm bullish long term.

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