Walgreen reminded of European risks with Celesio's flop

As Deerfield-based Walgreen Co. spends $6.7 billion on a foray into Europe, a small German online pharmacy offers a reminder about the potential pitfalls.

Ralf Daeinghaus sold his DocMorris online pharmacy to Celesio AG in 2007 for about $258 million, and the buyer set in motion an expansion plan to bring lower- cost drugs to more European consumers. Five years later, Celesio has written down the value of DocMorris to 40 million euros and put the business up for sale, stymied by laws against corporate ownership of drugstores.

With medical costs rising and Europe's governments cutting spending amid the debt crisis, the idea of increased competition in health-care retailing should be more appealing than ever. Yet Daeinghaus's entrepreneurship ran up against the political clout of German pharmacists and European opposition to a freer market in medicine sales. Walgreen, the largest U.S. drugstore chain, bought 45 percent of Alliance Boots GmbH in August, with the option to buy the remainder.

“It's really crazy, isn't it?” Daeinghaus, 45, said as he sat in a coffee shop this month near his office in Dusseldorf. “It's not a problem to liberalize the market a bit. When there's competition, there are price and quality improvements.”

In Germany, Europe's biggest market for pharmaceuticals, it is a problem. Each of the 27 European Union countries sets its own rules for pharmacies, and Germany, France and Italy have the most stringent. Under German law, an “apotheke” or drugstore must be owned by a pharmacist, and no pharmacist can own more than four stores, which must be located near each other. The government limits the profit margin pharmacists can earn.

“In Germany the pharmacies have a very strong lobby,” said Bjoern Weber, a research director for Planet Retail in Frankfurt. “They are still seen in the public opinion as a guarantee against counterfeiting or getting the wrong product.”

That means Deerfield, Illinois-based Walgreen, which is seeking to become a global pharmacy company, must steer clear of a big swath of Europe. Alliance Boots, based in Zug, Switzerland, operates 3,200 pharmacies in the U.K., Norway, Ireland, the Netherlands and Lithuania, and a wholesale business that supplies 170,000 outlets.

“Much of Walgreen's expansion in the region is limited,” Ross Muken, an analyst at International Strategy & Investment Group in New York, said in an e-mail Oct. 10. “The mom-and-pop pharmacies basically block the entry of large chains.”

Alliance Boots has focused on areas with more open markets such as the U.K, and Walgreen may look to expand in eastern Europe, China and Brazil, said Muken, who has the equivalent of a sell recommendation on Walgreen shares.

Walgreen Chief Executive Officer Greg Wasson told analysts on a Sept. 28 conference call that Alliance Boots gives Walgreen “the opportunity for expansion beyond the U.S. and Europe.” Walgreen has an option to buy the remaining 55 percent of Alliance Boots over the next three years.

Walgreen declined to elaborate on previous comments by executives, Michael Polzin, a company spokesman, said yesterday by e-mail.

Daeinghaus tried to work around German restrictions in founding DocMorris. He set the company up in the Netherlands in 1999 because a German online pharmacy retailer at the time was verboten, a restriction the country eased in 2004. When he expanded into bricks-and-mortar stores by opening a DocMorris pharmacy in the German state of Saarland, pharmacists sued in 2006, saying it broke the law on ownership.

Having exhausted his marketing euros on lawyers and lobbyists, Daeinghaus sold the company to Stuttgart, Germany- based Celesio in 2007. He now runs a Kunesto GmbH, a company that offers excursions. In announcing the deal, Celesio Chief Executive Officer Fritz Oesterle said it would be just a matter of time before markets such as Germany opened up to competition.

In May 2009, the European Court of Justice upheld a ban on retailers owning pharmacy chains in Germany and Italy in a suit brought by a German pharmacy trade group. Similar bans in at least 10 other countries were at stake in the decision.

German pharmacists are unapologetic. “A neighborhood network of independent pharmacies in an aging society is not a luxury, but something we need,” said Heinz-Guenter Wolf, president of the ABDA, an association representing German pharmacists.

To get around the ban on pharmacy chains, Celesio sold the DocMorris brand to pharmacists as a franchise.

To be sure, Celesio may not have been the best owner for the business. The company is Germany's biggest wholesaler of pharmaceuticals, so pharmacists viewed it as a supplier and a competitor at the same time.

Oesterle left Celesio in 2011, and his successor, Markus Pinger, said in March that the company would sell DocMorris to end the conflict with its pharmacist customers. Celesio has received interest from private-equity firms and companies in the industry, and hopes to strike a deal by the end of the year, Chief Financial Officer Marion Helmes said in August.

Celesio declined to comment this week on the sale process, and declined to make an executive available to comment on the company's experience owning DocMorris.

Celesio had 160 DocMorris-branded pharmacies in Germany at the end of 2011, according to its annual report, and they will return to independent ownership after the sale. The company is committed to operating pharmacies in other parts of Europe and had 2,281 retail pharmacies in seven countries including the U.K. and Norway at the end of 2011.

As of August, German Internet and mail-order pharmacies are no longer allowed to offer a discount on prescription drugs and must offer the same price as bricks-and-mortar stores. The ban on rebates eliminated an incentive for Germans to go online for medicine, said Weber, the Planet Retail analyst.

German consumers are accustomed to life without corporate pharmacies, he said.

“People are aware that the prices are higher,” he said. “In Germany we have a saying about ‘Apotheke prices.' If you are at a restaurant and they charge you too much, we say these are ‘Apotheke prices.”'