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Walgreen-Rite Aid deal odds now 50-50

April 13, 2017

Leerink sees the odds of the Walgreens Boots Alliance Inc WBA 0.13%-Rite Aid Corporation RAD 3.79% deal going through as 50/50.

Walgreens negotiated a revised agreement on January 30 to acquire Rite Aid for $6.50 to $7 per share, depending on the number of Rite Aid store divestitures. The deal price would be $7 per share if 1,000 or fewer stores would be required to be divested by the FTC and $6.50 per share if more than 1,2000 stores were to be divested.

Fred’s confirmed it’s committed to buying up to 1,200 Rite Aid stores to help the Walgreens-Rite Aid deal to go through.

Divested Rite Aid Store To Be Kept Open

Analysts David Larsen and Matt Dellelo indicated Fred’s would be the third-largest retail store chain in the country following the deal, a distant third with about 1,648 stores compared to Walgreens’ 11,673 stores. Fred’s is concentrated in small towns in the Southeast, while Rite Aid is nationwide.

“While different in geography and average size, we believe FRED is committed to keeping the RAD stores open and is not doing the deal to purchase volumes,” Larsen and Dellelo said.

With the company setting its sights on becoming a pharmacy-driven enterprise, the analysts feel Fred’s would want to keep the 865 Rite Aid stores open, which in turn would earn the favor of the FTC.

See Also: Baird Updates Its View On Walgreen’s With New Rite-Aid Assumptions

Fred’s & Rite Aid – Equals Among the Weak

Leerink noted both Fred’s and Rite Aid have struggled in recent quarters, with slowing/declining revenue, negative same-store sales growth and shrinking or negative EBITDA margins.

“To finance the deal, we estimate FRED needs to borrow ~$1.1B assuming 1,000 stores (midpoint of WBA’s revised deal) at an average price of $1.1M”, the firm believes. This will engender a NEWCO with a leverage ratio of 4 to 7 times and interest coverage of 2 to 4 times depending on Rite Aid store sales and EBIT margin assumption.

Analyzing the financials, the firm thinks FTC is scrutinizing the scenario and is worried about Fred’s closing stores and/or raising prices.

Not-so-favorable FTC Make Up

Once Walgreens confirms certified compliance, Leerink estimates a 20-day clock will start ticking for the FTC to review the deal and make a decision.

“Meanwhile press reports have indicated that current chairman Ohlhausen (R) has given approval to staff to draft a legal complaint to block the deal,” the firm noted.

Given the ongoing wave of generic launches, a shift toward lower cost providers of care, the increasing prevalence of specialty, and Walgreens’ sophisticated operational infrastructure, Leerink rates the stock an Outperform.

 

Latest Ratings for RAD

Date Firm Action From To
Apr 2016 Deutsche Bank Downgrades Buy Hold
Mar 2016 Credit Suisse Assumes Outperform
Jan 2016 Evercore ISI Group Downgrades Buy Hold

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