3 Things You Need to Know If You Buy Walgreens Today

Walgreens Boots Alliance (NASDAQ: WBA) is one of the largest pharmacy retailers in the United States. Over the past several years, the company has made a number of poor investment decisions. As management looks to turn the business around, Walgreens has become a special situation stock.

There are very important implications to consider before you buy the shares today. Here are three things you need to know if you are considering buying Walgreens stock today.

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1. Walgreens is a special situations stock

The term "special situations" covers a lot of ground on Wall Street. In the case of Walgreens, the situation that is special is that the company is being taken private. Essentially, it is being bought by Sycamore Partners, which describes itself as a private equity firm specializing in retail, consumer, and distribution-related investments.

Image source: Getty Images.

There are implications for the stock, which are discussed below, but the big question that should be on an investor's mind is "Why is this happening?" The answer is that Walgreens operates in a mature market -- drug stores -- that is highly competitive. Looking for a way to continue growing, management attempted to reach beyond the retail sector. It tried being a drug distributor, and it didn't work out. It tried opening health clinics, and that didn't work out. Meanwhile, the core retail business has struggled.

At this point, it appears as if Walgreens needs a material overhaul that will be better handled outside of the public markets. This will allow decisions to be made that investors might not like, such as shrinking the business. Simply put, if you buy Walgreens today, you are buying a business that is struggling.

2. Walgreens' upside is capped, and there is material downside risk

When a company is bought out, like the plan is for Walgreens, there is an offer price. The offer price here, to which Walgreens has agreed, is $11.45 per share in cash. If the deal goes through, that is all that a shareholder can be confident in collecting.

Today Walgreens' share price is just a few cents below that price. So, basically, buying today will leave you with, at best, a couple of percent of guaranteed upside (or less) if the deal is consummated as expected. But what about the downside? The 52-week low for Walgreens' stock was a little over $8 per share. You can argue about whether or not that's a reasonable price, but if the deal falls through, the stock will almost certainly decline. And $8 is a fair assessment of the downside risk, given that the stock traded at that level not too long ago.

Essentially, if you buy Walgreens today, you are buying a stock where the downside risk could be much larger than the upside opportunity.

3. There's an upside wrinkle with Walgreens, but it is highly uncertain

To be fair, the upside is potentially larger than point two suggests. That's because there is an earn-out provision that could be worth up to $3 per share. That is not a guarantee; the number could be anywhere from zero to $3. And there's no time frame attached to that payment, either. It could happen in one day or much, much longer.

The earn-out provision is tied to the proceeds that Sycamore Partners may generate from selling Walgreens' health clinic business. There is likely some value in the business, but how much and how long it takes to realize that value is not clear. So investors buying Walgreens today are really betting that they will get that $3 fairly quickly.

The full amount would represent a roughly 25% gain over the buyout price, which is material. But the return falls materially if less than $3 is the outcome, and as time goes on, given the time value of money. In essence, you are gambling that there will be a quick and positive outcome with regard to the $3 earn-out provision with Sycamore Partners if you buy Walgreens today. Just go in recognizing that there's no way to actually predict what happens.

Only aggressive investors should buy Walgreens

The guaranteed upside is basically gone if you buy Walgreens, a troubled retailer, today. Investors buying it are effectively trying to play for that $3 earn-out, which isn't really the type of investment approach that most people use to create long-term wealth. If you are an aggressive and very active investor, Walgreens stock might interest you. But recognize the risks you are taking. For most, there are better investment choices for building long-term wealth.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.