CtW Investment Group Believes Longs RE Undervalued - Calls for Greater Disclosure

WASHINGTON, Sept. 3 /PRNewswire/ — The CtW Investment Group sent the
following letter today to Longs Drug Stores Corporation Governance and
Nominating Committee chairperson Dr. Mary S. Metz in response to the news
that Longs entered into a previously undisclosed agreement with
CVS/Caremark (CVS) not to reveal the value of its real estate portfolio.

The text of the letter follows:

September 2, 2008

Dr. Mary S. Metz

Chairperson, Governance and Nominating Committee

Longs Drug Stores Corporation

141 North Civic Drive

Walnut Creek, California 94596

Dear Dr. Metz,

We are disturbed by the news that Longs entered into a previously
undisclosed agreement with CVS/Caremark (CVS) not to reveal the value of
its real estate portfolio. We read public statements by David Heller, the
Chairman of Advisory Research Inc., concerning information to this effect
that he received from Longs’ Chairman and CEO Warren Bryant. Like Mr.
Heller, we view this as a highly questionable decision on Longs’ part,
since we believe there are reasonable grounds to suspect that the current
tender offer from CVS, which the Longs board has endorsed, undervalues the
company’s real estate assets. We urge you, as Chairperson of the Longs
board’s Governance and Nominating Committee, to immediately disclose any
such agreement, if it exists, and to explain to shareholders why the board
agreed to withhold information necessary for shareholders to make a fully
informed decision with respect to the CVS offer. If no such agreement
exists, we urge you to comply with Advisory Research’s request and disclose
additional information concerning the value of the real estate portfolio,
preferably via an independent, third party appraisal.

Given the numerous concessions already disclosed that Longs’ board made
to CVS in its negotiations, including a price at the low end of the range
that Longs had believed appropriate, a termination fee that exceeds the
rule-of-thumb for transactions under Delaware law, and limitations on
Longs’ ability to seek out or accept a superior offer from other potential
acquirers, among others, it is critical that shareholders have the
information they need to determine if tendering their shares is in their
best interest. The timely disclosure of an independent, third party
valuation of Longs’ real estate holdings would allow Longs’ shareholders to
make a fully informed decision at this critical moment.

The CtW Investment Group works with pension funds sponsored by unions
affiliated with Change to Win, a federation of unions representing more
than 6 million members. Many of these funds are substantial long-term Longs
shareholders.

1. Reason to Question Offering Price

Since the announcement of the merger agreement, the two largest
shareholders in Longs have expressed the view that CVS’s $71.50 offer
appears to undervalue the company. Both Pershing Square Capital Management
and Advisory Research have argued that the apparent valuation of Longs’
real estate portfolio is too low. We agree with Pershing Square and
Advisory Research that there are solid grounds on which to question the
valuation the CVS offer ostensibly places on Longs real estate portfolio,
and hence on the company as a whole.

In a number of statements, CVS has indicated that it valued Longs’
wholly-owned (buildings and land) and partly-owned (building only) stores
together at more than $1 billion. Moreover, CVS has indicated that it views
such a valuation as conservative. In its press release announcing the
merger agreement, CVS noted that Longs owns over 200 store locations as
well as other properties, and stated that it has “conservatively valued the
store locations alone at more than $1 billion.” During the companies’ joint
conference call following the merger announcement, CVS Chairman and CEO Tom
Ryan was asked what capitalization rate had been assumed by CVS in
connection with its valuation of Longs real estate, and Ryan again
emphasized that “it’s a conservative - it’s a decent — a reasonable
[capitalization rate].” These statements certainly suggest that Mr. Ryan
believes that the “more than $1 billion” valuation for Longs’ owned retail
real estate is if anything on the low rather than the high end of
reasonable estimates.

Indeed, in the discussion of the background to this transaction, the
tender offer statement suggests that Longs’ Chairman and CEO Warren Bryant
may have shared this view. For instance, on July 8, 2008, Mr. Bryant
“conveyed [to Mr. Ryan] his expectation that the offer price would be in
the mid-70s,” and on July 31 Mr. Bryant “reiterated [to Mr. Ryan] Longs
position on price.” Each of these reported conversations took place after
CVS submitted a non-binding letter to Longs that outlined a price range of
$70-$76 per share, which reinforces our sense that Mr. Bryant and Mr. Ryan
each recognized that Longs’ fair value likely exceeds the $71.50 price per
share that Longs’ board eventually approved.

2. Estimating the Value of Longs’ Real Estate

In light of these credible grounds for questioning whether the CVS
offer provides adequate consideration to Longs’ shareholders given the
value of the company’s real estate, we have estimated the value of these
properties using two methods. First, we have surveyed all retail drugstore
sales since January 1, 2006, in those states where Longs wholly- or
partly-owns stores: California (88% of Longs’ owned stores), Nevada (4.7%),
and Hawaii (7.3%). We calculate an average price per square foot for retail
drug stores in each state based on the sales data. Next, Longs states in
its most recent 10-K that the company wholly-owns 28% of its stores, or 141
stores, and partly-owns 13%, or 67 stores. Finally, Long’s reports that 92%
of its stores have square footage averaging 23,000, while its remaining
stores are averaging under 4,000 square feet. For the purposes of these
estimates, we conservatively assume square footage per store of 20,000,
below the weighted average of 21,480. Multiplying this estimate by the
average price per square foot for each state, and weighting by each state’s
share of stores, we estimate the value of the 141 wholly-owned stores at
approximately $1.04 billion.

To estimate the value of the partly-owned stores, we examined the
assessments of land value and calculated the average ratio of land value to
sale price for retail drug stores in each state. We then calculated the
value of the 67 partly-owned stores as above, and reduced their value by
this ratio. These calculations yielded an estimate of $229 million, for a
total valuation of Longs’- owned store portfolio of $1.26 billion. This
estimate exceeds by over 25% the minimum value of $1 billion that CVS has
ostensibly attributed to this part of Longs’ real estate portfolio.

Second, we estimated the value of Longs’ owned store portfolio based on
the “conservative” capitalization rates identified by Mr. Ryan during the
joint conference call in his response to the question noted above. After
noting that the capitalization rate applied would depend on the state and
market where the store is located and whether the store was wholly- or
partly-owned, Mr. Ryan stated that “the range is going to be in the 6.5,
7.5, 7 to 7.5.” We assume that Mr. Ryan’s qualifying comments indicate that
the lower end of the range (which would indicate a higher asset value)
would be applied to the wholly owned stores and the higher end of the range
to the partly-owned stores. Using Longs’ EBITDA for the year to July 31,
2008, of $280.1 million, and considering that the retail drugstore segment
of the company accounts for approximately 70% of operating profit, we
estimate that the retail drug segment generated EBITDA of $196 million.
Since 28% of its stores are wholly-owned, we estimate their contribution to
EBITDA to be $54.9 million. Using the low-end capitalization rate
identified by Mr. Ryan, we estimate the value of these stores at $845
million. For the partly-owned stores, which constitute 13% of Longs’ total,
we estimate they generated EBITDA of $25.5 million. Using the high-end
capitalization rate identified by Mr. Ryan, we estimate the value of these
stores at $340 million. Combining these values, we estimate the
Longs’-owned store portfolio is worth $1.18 billion.

Both methods we have utilized suggest that the $1 billion price tag CVS
has ostensibly attached to Longs’ drug store properties underestimates
their true value significantly: by at least 18% and by perhaps as much as
26%. Moreover, Longs owns significant other properties: three office
buildings, three distribution centers, and a number of additional retail
and undeveloped properties. Using reported assessments or (where available)
current asking prices, we estimate these additional properties are worth
$140 million. Given that the current CVS offer of $71.50 per share would
provide shareholders with a total consideration of $2.57 billion, and
assuming that this price reflects the valuation of Longs’ retail store real
estate at least $1 billion, we can estimate that CVS has attributed up to
$1.57 billion to value in Longs not associated with retail real estate
ownership. Adding this estimate to our estimate of the market value of
Longs’ real estate implies a fair value for Longs of between $76.62 and
$78.81 per share.

In its recommendation that shareholders accept the CVS offer, the Longs
board of directors stated that it believed Longs “would not be able to
readily liquidate or monetize its real estate in a manner that would be
certain to yield value to the Company and its shareholders in excess of the
Offer consideration and that there were significant tax implications to
doing so.” This argument seems strangely incongruous, both because CVS has
clearly stated that it intends to pursue a series of sale-leaseback
arrangements to monetize this portfolio (an option Longs presumably could
have pursued), and because any such view on the board’s part would not
justify recommending acceptance of a tender offer that undervalues
shareholders’ investment. It is or should be within the board’s power to
clarify this issue by disclosing an independent valuation of its real
estate holdings.

3. Deal Protections Increase the Urgency of Full Disclosure

Such full disclosure is all the more urgent given the extensive deal
protections CVS has secured, and to which the Longs board agreed. These
protections will likely have the effect of deterring potential alternative
suitors, thereby limiting Longs’ shareholders to the choice of the CVS
offer or no transaction. These protections include:

— a termination fee payable by Longs to CVS of $115 million or 4.6% of
deal value, above the 3% threshold that serves as a rule-of-thumb in
Delaware;

— a “top-up” option allowing CVS to purchase from Longs any shares it
needs following a successful tender to complete a short-form merger;

— a joint application to the NYSE for an exemption from Rule 312,
which could otherwise require Longs to hold a shareholder vote if exercise
of the top-up results in Longs issuing more than 20% of shares outstanding;

— a “last look” provision that grants CVS five days to respond to a
superior, third-party merger proposal; and

— a requirement that CVS receive any materials Longs delivers to a
third party related to such a superior merger proposal.

Considering further the merger agreement states shareholders will not
have appraisal right with respect either to the tender offer or the merger,
it is imperative that the board ensure shareholders have the information
they need as soon as possible.

Conclusion

If in addition to these deal protections, Longs also entered into an
agreement with CVS not to disclose the value of its real estate portfolio,
then the Longs board of directors has a clear duty to disclose this fact to
its shareholders, and to explain how such an agreement serves the interests
of Longs’ shareholders. If no such agreement exists, then the Longs board
should quickly grant the request of Advisory Research, Inc. and provide
additional information to shareholders concerning the value of its real
estate portfolio, ideally by disclosing an independent, third-party
valuation of these properties.

I look forward to hearing from you soon, and if you have any questions
concerning this letter, please contact me at (202) 255 6433.

Sincerely,

Richard W. Clayton III

Research Director

cc: Longs Board of Directors

Real Estate Central

CtW Investment Group Believes Longs RE Undervalued - Calls for Greater Disclosure

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