Walgreens cuts offer for Rite Aid, casting doubt on merger; analysts say deal still alive

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The News:

Walgreens Boots Alliance (Deerfield IL) on Monday (January 30, 2017) entered into a new agreement with Rite Aid (Camp Hill PA) to buy the drugstore chain for at least $2 less per share and potentially divest more stores. That sliced the deal value by $2 billion and extended the deadline to close the troubled transaction by six months amid concerns about their ability to win government approval for their merger, says Fortune.

@Walgreens entered into a new agreement with @RiteAid at a reduced value of $2 billion Click To Tweet

The drugstore giant has been working to win over regulators at the Federal Trade Commission in order to complete its acquisition. But the FTC so far has balked at a plan to divest 865 Rite Aid drugstores to Fred’s Inc. (Memphis TN), for $950 million.

The deal, worth about $9.4 billion when it was announced in October 2015, is now worth between $6.8 billion to $7.4 billion after Walgreens lowered its offer to between $7 and $6.50 per share from $9.

The acquisition, which would create the largest chain of US drugstores, ahead of CVS Health (Woonsocket RI), has so far failed to win approval from the FTC or assuage its anti-trust concerns. The government wants the combined company to carve off a large portion of its stores, the exact number of which has been the sticking point and the reason for the new price range of the deal.

In addition, Walgreens said it will be required to divest as many as 1,200 Rite Aids “and certain additional related assets if required to obtain regulatory approval,” according to Forbes.  That means the specific price of the total Rite Aid purchase will:

“be determined based on the number of required store divestitures, with the price set at $7.00 per share if 1,000 stores or fewer are required for divestiture and at $6.50 per share if 1,200 stores are required for divestiture.”

The announcement Monday comes after weeks of haggling with FTC lawyers on a way for Walgreens to buy Rite Aid. A merger agreement that expired last Friday night to complete the transaction has now been extended from Jan. 27, 2017 to July 31, 2017 “in order to allow the parties additional time to obtain regulatory approval,”

Walgreens said. It’s unclear whether Fred’s will remain the only buyer for all of the Rite Aids that could potentially be divested. But the existing deal with Fred’s hasn’t changed for the 865 Rite Aid stores. “Our agreement with Fred’s remains in place,” Walgreens said.

Antitrust regulators are also concerned that such a large drugstore chain could have too much clout with pharmacy-benefits managers like CVS Health or Express Scripts (St. Louis MO), which handle corporate and government drug plans.

The Wall Street Journal reported the previous week that Walgreens CEO Stefano Pessina told investors the companies were discussing “all instruments and actions” to win the FTC’s approval but that Walgreens had no backup plan if the deal gets rejected, an outcome he called “unthinkable.” Walgreens is itself the result of a massive merger two years ago between Walgreens and European druggist Alliance Boots.

Because of the new terms, Walgreens “no longer expects any material accretion in fiscal 2017,” according to Forbes. Thus, Walgreens has adjusted its fiscal 2017 net earnings to between $4.90 and $5.08 per share. “The company continues to expect that it will realize synergies from the acquisition of Rite Aid in excess of $1 billion, to be fully realized within three to four years of closing the merger,” Walgreens said in a filing Monday with the Securities and Exchange Commission.

Steve’s Take:

It’s déjà vu all over again, as Yogi Berra was fond of saying.

The clock ran out once more on Friday for the merger agreement between Walgreens and Rite Aid. The two giant pharmacy retailers initially announced a proposed merger on Oct. 27, 2015, with the intention of closing the deal within 12 months. When it became apparent that the US government would take longer to complete its antitrust review, the date was extended to Jan. 27, 2017. Now that date has come and gone. So what’s in the cards for this next go around?

As expected, Walgreens and Rite Aid chose the easiest path in light of ongoing FTC review of the proposed deal. The companies announced another extension of the merger agreement. The brand-new expiration date of the agreement is July 31, 2017. That’s a mere 21 months from the date of the original merger agreement.

This latest extension brought some unwelcome news for Rite Aid shareholders, Motley Fool points out. Originally, Walgreens offered to buy Rite Aid for $9 per share. The amendment to the agreement that extends the end date also lowers the offer price to a maximum of $7 per share and a minimum of $6.50 per share.

Adding to the uncertainty, there is a range for the new offer price because the actual price paid will depend on how many Rite Aid stores Walgreens is required to sell. Walgreens initially planned to sell up to 1,000 stores. The company has increased the number of stores it’s willing to sell to 1,200.

If the FTC requires Walgreens to sell 1,000 stores or fewer, the company will pay Rite Aid shareholders $7 per share. If Walgreens is required to sell the full 1,200 stores, Rite Aid shareholders will only receive $6.50 per share. If the actual number of stores sold falls between those numbers, the price per share paid will be pro-rated.

Monday’s announcement definitely spawned winners and losers. Rite Aid was the chief victim. The pharmacy chain’s stock crashed, closing down 19% so far on the week to $5.62.

Rite Aid’s stock dive actually could have been worse, the Fool suggests. The maximum share price with Walgreen’s revised offer is 22% lower than its previous offer. The minimum share price offer reflects a decrease of nearly 28% from the initial offer.

Walgreens emerged as the beneficiary. The big pharmacy giant’s stock traded slightly higher at $81.94 after the market opened. While Walgreens might have to give up more stores to bag Rite Aid, it will pay a significantly lower price should the transaction win regulatory approval.

Now that’s the kind of winning hand that everyone dreams about!

Steve's Take: The bigger winner isn't @Walgreens or @RiteAid - it's @FredsInc Click To Tweet

But perhaps the biggest winner of all was Fred’s. Its stock jumped 3% to $14.57 at closing Tuesday following the announcement of the new merger terms. Back on Dec. 20, 2016, Walgreens and Rite Aid announced plans to sell 865 Rite Aid stores to Fred’s to help assuage any FTC concerns about possible post merger non-competitiveness.

Reading the fine print of the initial agreement with Fred’s explains why the company’s stock rose after the announcement by Walgreens and Rite Aid. That agreement says that if the FTC requires Walgreens to sell more than 865 Rite Aid stores, Fred’s will purchase the additional stores.

Fred’s was already on track to become the third-largest pharmacy chain in the US under the original deal terms. Now it appears the company could grow even larger than it initially contemplated.

Of course the $64 question (alright, the $7-billion one) is: Will the FTC ever wave the deal through no matter what the various drugstore reconfiguration scenarios might be?

That’s a toughie because in the companion health-insurer theater, for example, a federal judge just sided with the Justice Department against the merger of Aetna-Humana.

Absent a Wal-Mart purchase of the entire US drugstore marketplace, I’m siding with Evercore ISI analyst Ross Muken who maintained his “buy” rating on Walgreens stock, stating that although its proposed deadline for a deal with Rite Aid has been delayed, “there is still a chance of a reasonable outcome for both parties.”

Muken reasons, “On the [Walgreens] front, shareholders will be quite content to pursue this transaction (cost rationalization/ de-leveraging exercise) despite the elevated divestiture count with accretion/PF (periodic flow) leverage likely biased positively given the >20% haircut to deal value.”

He added if the FTC prefers a buyer other than Fred’s Pharmacy to purchase at least 865 divested Rite Aid stores, the timing of the deal’s closing date will likely change.

Then again, wildcards in this evolving scenario include President Donald Trump’s likely ability to nominate three new commissioners for the five-member FTC. I’d bet he’ll It seems likely he’ll put forward individuals who are not advocates of burdensome government regulation, which likely would facilitate approval of the Walgreens-Rite Aid deal.

Analyst Muken reminds us that, “Note, if a second buyer is required, this could likely result in the timing of the transaction to be biased toward the end agreement date (July 31) versus more near-to-medium term.”

Yes, that might add additional time. But consider that by comparison, the Exxon-Mobil, $82-billion deal that closed after FTC approval back on Nov. 30, 1999, only took the agency 11-months to review. At the time, review of that deal was one of the longest ever by the commission. We’re already at 15 months with Walgreens-Rite Aid. Anyone else see a new record in sight?