Business Analysis: Investors question chemistry of £7bn Boots-UniChem merger

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The Independent Online

If Boots and Alliance UniChem were under any illusion that their proposed £7bn tie-up was the solution to all their problems, then the City's reaction yesterday said it all.

Shares in Alliance UniChem, which have rocketed by one-third in the past 12 months, ended the day barely higher, while the 4 per cent rise in Boots was attributed as much to potential private-equity bid interest as the transformational qualities of the nil-premium merger with a pan-European drugs wholesaler.

Analysts and investors queued up to query the logic of either side pursuing a deal that veers wildly from existing strategies, while posing significant completion, integration and execution risk. Robert Talbot, the chief investment officer at Royal London Asset Management, said: "Shareholders are pretty sceptical and have yet to be convinced that this transaction actually enhances the growth prospects of either company."

Boots' shares eased back from a 49p rise to close 24.5p higher at 633p and shares in Alliance UniChem ended merely 1 per cent higher at 875p after falling back from an early high of 910p.

The European competition authorities will have first call on whether to investigate the deal. Meanwhile, expect there to be a myriad of complaints to the UK's competition watchdog from independent pharmacists. The new group, Alliance Boots, will have 17 per cent of the UK retail market, leapfrogging Lloyds Pharmacy as the nation's biggest chain with its 2,500 outlets. Its will also make it the country's biggest drugs wholesaler, ahead of Germany's Celesio, with 40 per cent.

The combined onslaught of the four men who will run the enlarged group - Nigel Rudd, the chairman, Stefano Pessina, the executive deputy chairman, Richard Baker, the chief executive, and George Fairweather, the finance director - failed to convince a sceptical City of the deal's rationale.

Philip Dorgan, the retail analyst at Panmure Gordon, said: "Retail mergers normally fail. Boots needs to sort out its core business - I've never known a company do a big acquisition from a position of weakness and succeed. With regard to Alliance UniChem, it depends whether the business has gone ex-growth. This could be a case of two drunks propping each other up."

One investment banker who had worked on the deal declared it had taken two years to pull off, while Mr Pessina, Alliance UniChem's founder and 32 per cent shareholder, said Mr Baker was the third Boots' chief executive he had tried to woo.

Analysts at Citigroup saw Boots' acquiescence as "capitulation" from a position of "severe weakness". The deal, they added in a note, "seems to be an admission that the stand-alone entity has poor prospects despite the current team's major efforts to reverse damage done by previous flawed strategies". At Lehman Brothers, the view was that the proposed £100m of cost savings over the next four years were already reflected in Alliance UniChem's valuation and that "the proposed deal is very weak from the view of Boots' shareholders and likely to fail".

The US broker sees investors in Boots gaining less cash than anticipated from the sale of its Nurofen and Strepsil manufacturing division - just the surplus after £400m profit is retained for investment rather than the bulk under the original proposal - and also contributing a better quality business with higher margins. Despite the 50:50 terms of the merger, Boots is contributing 60 per cent of the combined group's earnings before interest, tax, depreciation and amortisation and asking shareholders to swallow an implied dividend cut given that spare cash will be spent on Mr Pessina's "acquisition pipeline".

Stewart Fowler, the head of UK equities at Axa Investment Managers, said: "They don't seem the most obvious corporate combination. It's probably a less bad solution for Boots but that doesn't make it a good idea and it's difficult to see what Alliance UniChem gets from giving up its independence."

The new group has earmarked £100m of cost savings by the fourth full year after completion, with £60m coming through by year two. The bulk will come from combining the purchasing and wholesale networks, while axing 1,000 jobs (out of a group total of 100,000) will contribute another £20m. It will cost Alliance Boots £60m cash to make the savings. In addition the departure of Ian Meakins will cost the new group £4m.

After the sale of Boots Healthcare International, which could fetch £1.8bn, the combined group will have a total pro forma operating profit of £711m on turnover of £13.8bn. It will have more than 3,000 stores, including 90 per cent with pharmacies, across seven countries. In its core UK market it will be poised to benefit from the Government's push to ease the burden on the National Health Service by devolving more power to local pharmacists.

Mr Baker, who will leave the strategic decisions to Mr Pessani, said he was mindful of the pitfalls thrown up by Wm Morrison's botched takeover of Safeway. Mr Pessani pointed to his strong track record - he pulled off the merger of Alliance Santé with UniChem in 1998, pledging the word "alliance", "symbolises how we will work together". But analysts questioned how the marriage would work in practice - presupposing that no financial or trade buyers steam in to break up the party, triggering multimillion-pound break fees.

A prescription for success or failure?

Stefano Pessina says he came to drug wholesaling "almost by chance" in the 1970s, after having originally begun pursuing an academic career in nuclear engineering. The thickly accented Italian says he saw the potential for consolidating his country's fragmented drug-distribution industry, and bought a small company set up by his father in order to do just that.

He didn't stop at the Italian border, buying businesses in France and then across the Continent, building up Alliance Santé, which he sold to UniChem in 1997 for £327m. Italy's "clean hand" anti-corruption campaign, which was dogging his other business interests at the time, subsided without any charges being pursued.

Almost 30 years since his first acquisition, now aged 63, he is sitting on a billion-pound paper fortune and still doing audacious deals. Despite not sleeping for two nights, he was still able to mount an enthusiastic performance for the City yesterday, talking of driving the Boots brand across Europe.

Despite a lavish lifestyle based in Monte Carlo, Mr Pessinais wedded to the business. His affair with Ornella Barra, an Alliance UniChem board member, allows him to mix business and pleasure. He has two children.

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