Walgreens Could Use a Prescription for Ailing Drugstore Business

(Bloomberg Businessweek) --

When billionaire Stefano Pessina took over as chief executive officer of Walgreens Boots Alliance Inc. in 2015, he soon began hunting for his next big deal. By October of that year, he’d found it: a $9.4 billion plan to buy Rite Aid Corp. that would have vaulted Walgreens past CVS Health Corp. to become by far the largest U.S. drugstore chain. But after he spent almost two years wooing government officials and investors, regulators prevented Walgreens from swallowing Rite Aid. In September 2017, Pessina had to settle for buying 1,932 Rite Aid stores, less than half as many as his original target.

As it turns out, that might have spared Walgreens an even more painful reckoning than the one it now faces. On April 2 shares of the company plummeted 13 percent after it said earnings would be stagnant for the rest of its fiscal year, which ends on Aug. 31. Pessina, who owns 15.9 percent of Walgreens shares, lost $1.2 billion of his personal wealth in one day; the stock’s total decline since his Britain-centered Alliance Boots drugstore chain merged with the U.S.-based chain has reached 28 percent.

Walgreens’s troubles reflect a power shift that’s reshaping the entire prescription-drug industry, from the companies that research and manufacture pills to the insurance companies that pay for them. Washington’s clamor to reduce drug costs has compressed profit margins for physical drugstores such as Walgreens, CVS, and Rite Aid. Big Pharma isn’t raising the list prices of brand-name drugs as fast as they once did, limiting growth in the already small cut drugstores can make from new blockbusters. Meanwhile, pharmacies have been unable to make up the shortfall with bigger markups on generic medications, because those prices aren’t falling as rapidly as in years past.

Then there’s Amazon.com Inc. The giant online retailer has already made life miserable for drugstores by selling beauty products and over-the-counter cold remedies at rock-bottom prices. Now, after buying online pharmacy PillPack for about $1 billion last June, Amazon may be poised to undercut their prescription business. “It is the toughest environment I’ve ever seen” for pharmacies, says Goldman Sachs analyst Robert Jones, who cut Walgreens to a sell rating in December. “The core business is declining very rapidly.”

Perhaps most troubling, insurers are pitting pharmacy chains against one another as they seek to lock in low prescription costs. In the past, if a health plan left a major chain out of its network, it risked alienating members who may have fewer pharmacies nearby. Now there’s no such reluctance. With around 60,000 drugstores crowding American street corners, insurers can drop one of the two big chains without inconveniencing many consumers.

There are 9,560 Walgreens stores in the U.S. competing with 9,800 CVS locations and 22,000 community pharmacies. Then there are the pharmacies tucked inside food stores and big-box discounters such as Walmart. Those players are often willing to offer lower prescription prices to get shoppers through the door. These days, “nobody cares whether you have Walgreens in the network,” says Michael Rea, founder of Rx Savings Solutions, which has an app that helps patients find the best prices. “It is the same drug everywhere you go, and people don’t want to pay a premium because it has Walgreens on the bottle or CVS on the bottle.”

Insurers have increasingly embraced “narrow networks” that force patients to pay more to roam beyond preferred pharmacies to pick up a prescription. In 2019, 92 percent of Medicare drug plans used such networks, compared with 7 percent in 2011, according to Drug Channels Institute. Sixty-one percent of employers in 2018 limited pharmacy networks in some way, up from 36 percent in 2015, according to surveys by the Pharmacy Benefit Management Institute. A big reason: Health plans typically save 3 percent to 7 percent of total drug costs by adopting a narrow network, according to a white paper by DST Pharmacy Solutions.

So Walgreens is tightening its belt. It will try to shave more than $1.5 billion in annual expenses within three years and close 750 of the Rite Aid stores it bought. Walgreens declined to make Pessina or other executives available to comment for this article.

Some Walgreens competitors have adapted by broadening their businesses. CVS bought insurer Aetna for about $68 billion last year, in a deal premised on the idea that having health clinics and a drugstore under one roof would save consumers time—and save money by keeping people away from the hospital. The company also owns the giant drug-benefit manager Caremark, which allows it to cut deals with employers and health plans that steer patients to its stores.

The forces besetting Walgreens have also lashed CVS. Its shares have lost about a third of their value since touching a 52-week high in November. And CVS faces a threat that Walgreens doesn’t: With the business practices of pharmacy benefit managers under intense scrutiny in Washington, Caremark could find itself constrained by new regulation.

Walgreens has been attempting in the past year to make up some ground through a raft of collaborations, including a retail partnership with grocer Kroger Co., a drug-delivery pact with FedEx Corp., and a digital health effort with Microsoft Corp. And it plans to open 600 medical-testing locations of Laboratory Corp. of America Holdings in its stores.

Still, Walgreens’s fortunes remain tied to its stores, exposing it to the ongoing declines among so many retail segments. Comparable U.S. sales of “front of the store” items like makeup and shampoo, for example, have fallen slightly at Walgreens in every quarter since July 2016. “The reality is we probably have 20,000 too many pharmacies,” and they’re thousands of square feet too big, said Ross Muken, an analyst at Evercore ISI, in an April 10 webinar. For Walgreens, “there are just not a lot of clear answers what to do.”

To contact the editor responsible for this story: James Ellis at jellis27@bloomberg.net

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