Free at last, but what next for Boots after Walgreens demerger?

After numerous failed attempts at independence, Boots is finally operating as a standalone company once more. New owner Sycamore Partners completed its $23.7bn leveraged buyout of Walgreens Alliance Boots last week and split the sprawling group into separate parts.

Headquartered in the UK, The Boots Group includes the international operations of WBA, with the Boots high street chain the jewel in its crown, alongside the No 7 Beauty Company, responsible for the flagship No7 and Soltan brands, as well as a host of other exclusive ranges. A large pharmacy business in Germany, which accounts for about half of the group’s $24bn revenues, and an assortment of other overseas assets are also bundled up in the new entity.

Ornella Barra will continue to run the company, with her husband and business partner Stefano Pessina retaining a sizeable stake in Walgreens and The Boots Group as part of the Sycamore deal.

“A demerger can have a positive effect on a company that’s previously been a small part of a larger group,” say AJ Bell investment analyst Dan Coatsworth. “Spinning off the entity effectively frees up management to make more entrepreneurial decisions and not have a parent company dictate what they should do.”

A City source adds its destiny is now in its own hands and it can reinvest its own profits to improve the business.

Boots has been on a rocky ownership journey over the past two decades since being combined with Pessina’s Alliance UniChem in 2006 (see box below). It suffered from underinvestment in the early days following Walgreens’ takeover and has battled uncertainty in the past three years as its struggling parent tried to unsuccessfully offload the chain.

Today, having undergone a transformation under former boss Seb James, who handed over to Anthony Hemmerdinger in 2024, Boots is “probably one of the best run bits of the whole Walgreens empire”, according to the City source.

It follows about 500 underperforming stores being closed and hundreds of beauty halls revamped, driving market share gains. The online business is racing, now accounting for 17% of total retail sales, and the Advantage card loyalty programme continues to go from strength to strength with more than 17 million active users.

Boots UK – which registered a total turnover of £7.3bn in the year to 31 August 2024 – will now be looking to extend its run of 17 consecutive quarters of unbroken growth (with like-for-like growth of 6% in its third quarter to 31 May).

A clean break

A senior retail source highlights Boots has been the chief beneficiary from the liquidation of Lloyds Pharmacy, the collapse of Debenhams and the downscaling of House of Fraser. “It’s hard to replicate that scale beauty hall in a supermarket, so Boots should continue to have an advantage there, but when it comes to the less differentiated products, such as shampoos and general health and beauty products, the mults and discounters are much cheaper. It’s a really mixed picture.”

But is there a risk disentangling from the Walgreens universe will create distractions for Boots? Will it lose economies of scale or suffer from messy systems decoupling a la Asda?

The retail source anticipates a “clean break” given there was limited actual integration between Boots and Walgreens. “In a way, Boots was always an afterthought for Walgreens and they never really integrated systems in the same way that Asda and Walmart did,” he says. “The catastrophe of Project Future that Asda has been going through for four years won’t be repeated here. Plus, Boots has been primed for divestment for a while, so behind the scenes the separation model and actions have been pretty well rehearsed.”

S&P Global Ratings agrees, with execution risk from the separation reduced as the group currently runs independent IT systems and supply chains. But the ratings agency warns: “Subsequent to the separation from WBA, we understand The Boots Group will undertake a digital infrastructure transformation project, which could pose certain risks over the next few years.”

Arguably, the bigger risk is the amount of debt that comes with the typical leveraged buyout favoured by private equity, a burden Asda and Morrisons know only too well, not to mention Debenhams which eventually went bust under the weight of debt.

S&P gives The Boots Group a ‘stable’ outlook but notes the new capital structure will include $4.3bn of senior secured debt. However, the firm says, it understands the group’s strategy is to reinvest excess cash in the business and rapidly deleverage, rather than distribute it to shareholders.

Sycamore, a New York private equity firm specialising in distressed retail investment, is best known for ruthlessly stripping out excess costs and seeking efficiencies in its targets, extracting value quickly. When it bought Staples in 2017, the office supply chain was broken up immediately, with the consumer-facing and B2B operations separated, and the headquarters sold back to the PE firm for a fat dividend.

It will need to tread carefully with Boots, however. A much-loved British institution for meal deals, 3for2s and a leading health and beauty offering, and the place the nation heads to when sick.

Sycamore – in its deal completion announcement last week – paid homage to the chain’s “undisputed authority” in beauty, wellness and healthcare and its 176 years of history.

Sycamore managing director Stefan Kaluzny called The Boots Group “a remarkable institution with deep roots in its communities” and said it was now “free to invest and grow more aggressively into the future”, while Stefano Pessina added the investor group was “committed to investing” in the company “to accelerate its already very successful record of growth”.

A senior banker points out the significance of the continued involvement of Pessina and Barra in Boots. “This isn’t just a Sycamore deal, it’s a Sycamore and Pessina deal – probably with Pessina in charge,” he says. “That is particularly relevant in The Boots Group. The rumour is it could even be a 50/50 split in the UK and that means it is unlikely Sycamore will run the usual playbook. Staff in Boots should feel quite protected.”

The Sycamore slash-and-burn will likely happen in the US at the troubled Walgreens business, which has been hammered by structural issues in the country’s pharmacy industry.

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Coatsworth at AJ Bell notes cost-cutting was already in motion at Boots under WBA’s ownership, including lots of store closures. “Sycamore will no doubt encourage Boots to find more ways to trim costs, but companies cannot magic up massive savings at the click of a finger,” he says. “It takes time and effort to review and analyse, and Sycamore might simply be happy that Boots already has a plan in motion.”

The retail source adds more investment is needed in product innovation and outside of Boots’ destination stores but doesn’t see a case for further rationalising the shops in mid-sized towns.

“Boots is very concentrated in its top 500 stores and as long as they are healthy, there is marginal impact in keeping those local community pharmacies, which are quite important to maintaining engagement and its position as the nation’s largest health & wellness and healthcare provider.”

Paul Day, union director of the Pharmacists’ Defence Association, adds there is an opportunity for the new owners to invest more to enable pharmacists to make “an even greater contribution to the nation’s health, while having a manageable workload and delivering sustainable profits to the business”. “Without a pharmacist, a pharmacy simply becomes another shop competing for custom with other online and high street options, so our members role in providing the most accessible part of the NHS, a healthcare setting on the high street, continues to be the USP of the business,” he says.

What’s ahead for Boots?

If extreme cost-cutting is not on the agenda for Boots, what is the expected play?

Retail analyst Nick Bubb says an IPO is undoubtedly on the cards again. “Health and beauty is still the best performing non-food sub-sector and City investors are keen to find a way to play that market,” he adds. “Boots fits the bill, particularly now it’s online offer is much improved.”

Clive Black of Shore Capital reckons any realisation will be some time away, but the better Boots performs the louder the IPO chatter will be.

And the banking source doesn’t rule out the possibility of another PE buyout but warns Sycamore would need to be more realistic around valuation compared with Walgreens expectation for £7bn-£10bn.

“The investment hypothesis of the Apollo and Reliance consortium from last time still stands [reports in 2022 linked the two to a bid of around £5.5bn]. Reliance was very keen on using the Boots and the No7 brand and globalising it.

“And Asda’s owner TDR could also be interested again, particularly if Asda’s performance continues to turn around in the next two years. Even after everything TDR has been through, the Advantage card is a very powerful loyalty scheme and that provides an incentive.”

He adds: “Because Pessina is a consummate deal maker, I would bet he would want a role and equity stake in whatever deal came next. I wouldn’t rule out someone buying out Sycamore’s stake, with Pessina staying in with a different PE backer or a partial listing.”

Black argues the vagaries of the UK consumer will be the most important demand factor for Boots. “The trajectory around consumer spending will be important. The backdrop on household expenditure feels cooler rather than warmer, which means market share may become quite important over cash profit for any exit valuation criteria” he says.