Rite Aid (RAD), one of the largest drugstore chains in the US (4,500+ stores in 31 states), is trading sharply lower today on news that its agreement to be acquired by Walgreens Boots Alliance (WBA) has fallen through. The merger agreement had been signed in October 2015, but it's now terminated.
However, there is still a smaller deal. Instead of being acquired entirely by WBA, Rite Aid has agreed to sell 2,186 of its stores to WBA for $5.175 billion all in cash. As you can see, this is about half of its store base. Rite Aid will now be more of a regional drugstore chain instead of a multi-regional chain. In addition, the agreement provides Rite Aid the option to purchase generic drugs that are sourced through an affiliate of WBA at cost, substantially equivalent to Walgreens for a period of 10 years.
The 2,186 stores included in the agreement are primarily located in the Northeast, Mid-Atlantic and Southeastern regions of the US. The three distribution centers included in the agreement are located in Dayville, CT, Philadelphia and Spartanburg, SC. Rite Aid will provide certain transition services to WBA for up to three years after the closing of the transaction, which should happen within six months. The deal has been approved by the Boards of Directors of Rite Aid and WBA and is subject to antitrust clearance. Approval of this transaction does not require a shareholder vote.
Rite Aid expects to use a substantial majority of the money to pay down debt, significantly reducing its leverage levels. Rite Aid also expects that the federal tax gain on the sale of the assets will be largely offset by its net operating loss carryforwards, resulting in a minimal cash tax payment on this transaction. Following the deal, Rite Aid will continue to operate EnvisionRx, its pharmacy benefit manager, RediClinic and Health Dialog.
A big reason for the deal falling apart is feedback from the Federal Trade Commission (FTC) that led the company to believe that the parties would not have obtained FTC clearance to consummate the merger. The FTC is in charge of looking at anti-trust implications and one of its key goals is to ensure that there is enough competition in various markets. Apparently, the FTC was concerned that the merger of these two huge drugstore chains would have stifled competition. In connection with the termination, WBA has agreed to pay Rite Aid a termination fee in the amount of $325 mln in cash.
There is another player in this as well: Fred's (FRED), which operates Fred's Pharmacy. The RAD deal was signed in October 2015 and then FRED got involved in December 2016 to buy some of the stores, presumably to ease some FTC concerns. In light of the termination of the merger agreement, the divestiture agreement with Fred's was also terminated, effective today. In case you have not been following the Rite Aid story, Fred's Pharmacy, which is based in Memphis, TN and operates 601 pharmacy and general merchandise stores, had agreed in December 2016 to acquire 865 Rite Aid stores.
This would have been a transformative deal for Fred's as it would have more than doubled its store base. It appears that Fred's got involved to ease the FTC's concerns. Of course, FRED's portion of the deal was contingent on getting FTC approval for the WBA/RAD acquisition. With the deal now terminated, Fred's Pharmacy will receive $25 mln as reimbursement for transaction-related expenses. Fred's issued a press release saying it's disappointed by the deal falling through. However, the termination of the transaction has no impact on the company's transformation strategy.
In sum, RAD (-25%) and FRED (-23%) are trading sharply lower this morning while WBA is trading up (+3%) on this news. On the positive side, while Rite Aid investors are clearly disappointed the company is not being acquired, at least there is more clarity now. There have been doubts for some time whether the FTC would approve the deal. So that created a bit of a cloud over the stock. At least now, we know what's going to happen or at least we hope we do (we are assuming that the companies are confident this revised deal will pass FTC muster).
In addition, a 10-year deal to acquire generic drugs at cost is a nice aspect to the deal for RAD. Also, RAD points out that the new deal will help it address its pharmacy margin challenges and allow RAD to significantly reduce debt, resulting in a strong balance sheet and improved financial flexibility moving forward. WBA shareholders seem to prefer this smaller scale deal. But FRED shareholders are not happy the deal fell through as they missed out on an opportunity to double FRED's store base and become a more dominant player in the drugstore space.