Power Struggle at Walgreen as Biggest Shareholder Rises

By Cynthia Koons | Sep 10, 2014 7:01 PM ET

Stefano Pessina, an Italian-born nuclear engineer turned drug-store mogul, is emerging as a powerful force within Walgreen Co. (WAG) as it evolves from being the biggest U.S. pharmacy chain into an international retailer.

Pessina, 73, built Bern, Switzerland-based Alliance Boots GmbH through more than three decades of mergers before selling it to Walgreen last month. Now, he’s assuming a new role at Walgreen as executive vice chairman of the combined company, responsible for strategy and deals. Greg Wasson, 55, remains chief executive officer.

Investors say Pessina’s growing influence, with Alliance Boots lieutenants filling four of the merged company’s top nine positions, will push Walgreen from its neighborhood pharmacy role to the more stylish retail vision of Boots Alliance, which controls about 40 percent of the high-margin market for beauty products in the U.K.

“I’m glad to see more Boots people coming on board, I think everybody agrees that that’s the better run and more innovative company,” said Jeff Jonas, associated portfolio manager at Gabelli Funds, a Walgreen shareholder.

A change in Walgreen’s board will further strengthen Pessina’s position. This week, the company announced that it struck a deal with hedge fund Jana Partners LLC that allows Jana to hold two board seats and help choose a third, an agreement widely seen as favoring the former Boots chairman.

Hedge Fund Stake

In April, after Jana said it invested $1 billion in Walgreen, partner Scott Ostfeld said the company’s buyout of Alliance Boots and Pessina’s presence on the board “will lead to the revitalization of this iconic brand and produce years of earnings growth through synergies, fixing operations and improving capital allocation.”

Pessina’s rise inside the Walgreen universe dates to 2012, when Walgreen bought a 45 percent stake in Alliance Boots.

That agreement gave Pessina a seat on Walgreen’s board and 7.6 percent of the Deerfield, Illinois-based company’s stock. When Walgreen said on Aug. 6 that it would buy the rest of Alliance Boots for $15.3 billion, it made Pessina by far the biggest holder, with 16 percent of the combined company after the deal closes. Since Aug. 6, the shares are down 8 percent.

That same day, Walgreen unveiled a smaller-than-expected $3 billion share buyback and an about $2 billion cut to its adjusted earnings forecast, which sent the shares down as much as 16 percent and damaged the U.S. management’s reputation with investors. The chief financial officer and the pharmacy president both left their roles within weeks of the news.

Safe for Now

As for Wasson, who began his career at Walgreen as a pharmacy intern and has remained there since, his job appears safe for now.

“He has a lot of respect inside Walgreen, it’s better to have someone like him who’s a change agent than forcing some outside person on the company,” said Jon Wolfenbarger, director at Allianz Global Investors, the parent of which is Walgreen’s 18th biggest shareholder, according to data compiled by Bloomberg. “If things aren’t better in a year or two, obviously at some point, shareholders might want to have a different CEO.”

Pessina has been building his power base at Walgreen since at least 2013, investors say.

After securing his 7.6 percent stake, he began to personally visit fellow large shareholders to find what kinds of changes they wanted, according to three people who spoke with him at the time and asked not to be named because the talks were private.

Investor Lunch

At a July 2013 lunch with about 20 investors at the St. Regis hotel in midtown Manhattan, Pessina criticized Walgreen’s operations, saying they didn’t compare favorably with what Alliance Boots was doing in its London stores, according to one investor who attended. For example, Alliance Boots has about 40 percent of the beauty market in the U.K., while Walgreen has just 3 percent in the U.S., said Tony Scherrer, director of research at Smead Capital Management.

After the lunch, the investor said he asked Pessina what leverage he had to force changes without an operational role.

The stake he held in Walgreen was all the leverage needed, Pessina told him.

Alliance Boots spokeswoman Julie Longton said neither the company nor Pessina would comment on “private discussions between shareholders.”

Soon after that July lunch, the company began providing investor relations employees to accompany Pessina as he continued to meet with investors, said a shareholder who talked with him later. Michael Polzin, a Walgreen spokesman, declined to comment on shareholder discussions.

Tax Move

Management’s concerns about Pessina’s views at the time may also have been part of Walgreen’s decision not to move its tax address overseas, said a person familiar with the discussions.

While scrutiny from U.S. tax authorities has been cited by the company as a reason for not making such a move, the managers also privately discussed the fact that Pessina would gain more shares as a result of regulatory rules involving stock thresholds in an inversion.

That decision has since been criticized for costing the company as much as $4 billion in future tax advantages over five years, according to one estimate.

Pessina’s maneuvering is reminiscent of an earlier deal he was involved in. He was executive deputy chairman of Alliance UniChem Plc, and owned 30 percent of the business before it was sold to Boots Group Plc to create Alliance Boots in 2005.

History Repeating?

Boots’ CEO Richard Baker was put in charge of the joined companies, though not for long.

The business was subsequently sold to private equity firm KKR & Co. in 2007, which had teamed up with Pessina to do the buyout. Baker left after “discussing the option of continuing in a role as CEO,” according to a statement at the time. Fergus Wheeler, an external spokesman for Advent International Corp. where Baker is an operating partner, said Baker wouldn’t comment.

Even with Pessina bringing his business acumen to Walgreen’s executive team, Walgreen still has a lot to prove, according to Gabelli’s Jonas.

“It’s going to be an attractive company,” he said. “But there are going to be some bumps along the way.”

To contact the reporter on this story: Cynthia Koons in New York at ckoons@bloomberg.net

To contact the editors responsible for this story: Reg Gale at rgale5@bloomberg.net Drew Armstrong

©2014 Bloomberg L.P. All Rights Reserved