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Walgreen-ABC Deal Creates Massive Player in Drug Sales

While many investors and consumers might still be watching the Cyprus story play out, it’s important not to overlook a big deal between AmerisourceBergen (NYSE:ABC) — one of the largest pharmaceutical wholesalers in the world — and retail drug store chain Walgreen (NYSE:WAG).

Both stocks were up more than 5% late Tuesday on news of a 10-year supplier deal in which Walgreen can buy up to 7% of AmerisourceBergen shares and an additional 16% down the road through warrants.

Cardinal Health (NYSE:CAH), previously the supplier for Walgreen, was slumping almost 7% after being dropped for ABC.

So why does this deal matter? Well, let’s look at recent history for context:

WAG operates more than 8,000 drugstores, but in 2012 it snapped up a 45% stake in European pharmacy chain Alliance Boots for $6.7 billion. That added influence in almost 5,000 new locations in a new market.

Part of this expansionary move was to fend off some competitive pressure. Also in 2012, pharmacy benefits manager Express Scripts (NASDAQ:ESRX) merged with Medco to create the largest PBM in the nation with some 1.4 billion prescriptions filled annually and over $100 billion in annual revenue. As a benefits manager, ESRX processes payments and negotiates prices — and there was a big spat between the company and Walgreen over payment issues around this same time, showing the risk a massive PBM like Express Scripts posted to profitability.

Now we arrive at the current news, where Walgreen is getting cozy with its wholesaler in an effort to control costs on the front end.

Theoretically, a few years down the road Walgreen could have a majority stake in Alliance Boots and a significant ownership stake in ABC — giving it massive influence in the recession-proof area of prescription drugs.

Walgreen stock is up about 37% since mid-November as the dust settled from the ESRX dispute and other favorable headlines like this.

There obviously are lots of risks to retail drug stores, including the ugly margins on “front of store” purchases and the continued threat from online pharmacies. There’s also pressure to keep down drug costs, both from companies like Express Scripts who manage the benefits and from regulators after the Obamacare legislation and recent focus on healthcare costs.

However, Walgreen is the biggest fish in this business (by number of locations), and an alliance with ABC will help it prop up margins.

Similarly, AmerisourceBergen said, “the deal will add $28 billion in revenue and about 20 cents per share in earnings to its fiscal 2014 performance.”

There are a lot of winners here, both with the short-term pop and with the long-term margins and market share to be gained.

Don’t forget the 2.5% dividend on WAG stock, either, if you’re thinking long-term. The company has paid a dividend for 80 straight years, and it has paid higher amounts each year for the past 37.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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