In an attempt to keep pace with recently created pharmacy giant CVS/Caremark (NYSE:CVS), Walgreen (NYSE:WAG) announced plans to purchase Option Care (NASDAQ:OPTN), a provider of specialty pharmacy and in-home health care services.
A new approach
The move, announced earlier this week, is just the latest in a series of major changes taking place for the drugstore arena, as each of the major players fights for position in what's been and will continue to be a very lucrative market. In addition to the CVS deal with Caremark, Rite Aid (NYSE:RAD) has made its own deals, the biggest of which was its recently closed acquisition of rival Eckerd.
However, Walgreen had previously been the exception, choosing to grow by opening new stores, rather than through acquisitions. There were those who thought this was the better and safer approach. However, Walgreen soon realized it couldn't continue to adequately compete based simply on more locations and has drastically altered its strategy.
Walgreen quickly learned the acquisition game. Within the past year alone, it has completed several acquisitions of small specialty pharmacies and an operator of health-care clinics, topping them all with its proposed deal for Option Care.
About the deal
Option Care is a national provider of specialty pharmacy and home infusion services. Through its pharmacy services, it provides medications and treatments for patients suffering from complex diseases, including cancer and multiple sclerosis. It also provides therapy for patients requiring intravenous medication or nutrition.
This latest move greatly expands Walgreen's existing specialty pharmacy business, adding 100 locations to its current 45 home-care facilities. Option Care has the largest geographic coverage in the industry with 400 managed care organizations. Furthermore, through Option Care, Walgreen gains access to medications that currently have limited distribution, giving customers a reason to choose its drugstore over the competition.
The cost to Walgreen for expanding its footprint in the specialty pharmacy business wasn't cheap. The deal is valued at $850 million, including the assumption of debt. Walgreen will pay $19.50 per share, which is a 27% premium based on the previous closing price for Option Care's shares.
Despite the inherent premium it will pay, I think the price will be considered a value within the next couple of years. The drugstore is no longer merely a business of getting prescriptions filled, photos developed, and picking up some candy. It has now become a one-stop shop for all your health-related needs. The deal will position Walgreen as the fourth-largest specialty pharmacy business in the U.S., trailing CVS/Caremark, Medco Health Solutions (NYSE:MHS), and Express Scripts (NASDAQ:ESRX). Walgreen expects the specialty pharmacy and home infusion markets to generate $60 billion a year with an annual growth rate of 20%.
The risk
There are some concerns about Walgreen's ability to provide these more complex services. After all, the transformation from a drugstore retailer to a full-blown health-care provider is no small goal. Just because both businesses deal in medicine doesn't automatically imply they can be combined naturally. However, I do expect Walgreen to be successful. Recognizing the complexity of its new business, it will put the president of Medmark -- another specialty pharmacy Walgreen recently acquired -- in charge of running its new division.
There also may be concerns about Walgreen's continuing ambitious growth plans for its drugstore locations. According to management, the company is on track to exceed its goal of operating 7,000 locations by 2010. Having increased its locations by 500 in the past year, I see no reason to doubt it.
The Foolish bottom line
Walgreen may have been forced into growing its business via the specialty pharmacy route as a result of the CVS/Caremark merger. Had it not, it would have no longer been able to compete on the same level. Instead, it would be left to battle Rite Aid for dominance of the pure drugstore market.
Which leads me to the likely biggest loser out of these recent transgressions. Rite Aid had finally made progress at being able to compete with CVS and Walgreen, but it now trails in the fast-growing specialty pharmacy business. Meanwhile, I expect CVS and Walgreen to be great long-term investments as the boomers age and become more reliant on their plethora of new service offerings. The deal may not have been in Walgreen's original plans, but it will be pleased it was forced to make the move.
For more on the transformation of the drugstore industry, check out:
Fool contributor Mike Cianciolo welcomes feedback and doesn't own any of the companies in this article.
