World’s Biggest Drug Deal – A Guest Post from Llenrock Group
Nov 12, 2015
This post from Eric Hawthorn is part of our Llenrock Group guest post series and originally appeared on the Llenrock Group blog.
The big news from the retail space last week was Walgreens‘ (NASDAQ: WBA) announced intention of acquiring its competitor, Rite Aid (NYSE: RAD), in a cash and debt deal valued at $17.2 billion. In what will surely be remembered as one of the most prominent U.S. M&A transactions of 2015, retail pharmacy giant Walgreens’ parent company, Walgreens Boots Alliance, hopes to acquire Rite Aid Corp. of Pennsylvania for $9 dollars per share–a deal that would make its store count and geographical reach 60% greater than its next largest competitor, CVS (NYSE: CVS).
A few fun facts. Deerfield, Illinois’s Walgreens, which has been on an international growth kick of late–acquiring Britain’s Boots retail chain and bringing foreign executives onto its team–has about 8,200 stores, according to this ranking. CVS is trailing in second place with nearly 6,300, followed by super center operator Walmart (3,600 pharmacies) and then, in fourth place, Rite Aid has about 4,600 pharmacies. This makes Rite Aid a huge acquisition target that would result in a a true retail behemoth. Analysts estimate that the deal will be completed mid-way through 2016, though there are still hurdles to overcome. Although both Walgreens’ and Rite Aid’s boards have approved this transaction, there may be challenges in winning a stockholder vote on the Rite Aid side (some believe Rite Aid is significantly undervalued in this transaction) and of course we have to think about antitrust regulation as well.
A few more fun facts, this time from a Wall Street Journal article published after the announcement. First we have to make note of the fact that about 15% of prescription drug transactions in the U.S. take place via mail order. In terms of this aspect of the retail drugs business, then, we see that Walgreens does not have quite as much market clout as its store footprint suggests. CVS, in fact, completes more Rx orders than its larger competitor, thanks to its early move into the mail-order side of retail pharmaceuticals. Many prescription drug plans require maintenance medications to be filled and refilled via mail order, since insurance companies and employers save a great deal by using this approach. Similarly, I would add, we have to consider how current dynamics in the U.S. healthcare and pharmaceutical spaces influence income from medicine sales. More and more medications are being produced cheaply, often as generics, which cuts profits. Similarly, pharmacies are often reimbursed less for certain drugs than before, and the economies of scale we see at the level of non-store drug plans like Caremark and Express Scripts make these competitors seem more financially practical.
Walgreens and Rite Aid, of course, believe this deal will increase shareholder value through the enormous market share that will result from the companies’ consolidation. It will also result in redundancies, a/k/a “cost synergies,” which Walgreens estimates will shave a cool billion dollars off its operating costs.
The goal of cost reduction, coupled with the potential that antitrust regulators air concerns over the companies’ collective store count, will inevitably result in store closures. The Wall Street Journal published a chart showing how the two drug store chains will overlap. In six states in the Mid-Atlantic and Northeast, the Walgreens deal will raise the company’s store count by more than 200%. In fourteen states, the portfolio of the combined entity will be doubled. From a market share perspective, it’s basically too much of a good thing.
Not only could this present a major challenge to government approval of this merger, it suggests resulting “synergies” (there’s that word again) will leave millions of SF in vacant space if/when the company pares down its portfolio. This could drastically soften fundamentals in community shopping centers, power centers, and especially freestanding triple-net properties–which in recent years have become a mainstay of the drug store sector thanks to their enormity and accessibility.
If you think about it, though, the retail drug market has been expanding significantly for years. Whether or not this proposed merger takes place, it seems this space is due for some compression.