A closed-door meeting at the FTC Thursday has prompted Rite Aid (NYSE:RAD) and Walgreens Boots Alliance (NASDAQ:WBA) to rethink their merger. The companies are abandoning plans for Walgreens Boots Alliance to acquire Rite Aid outright, and instead, Walgreens will only buy the Rite Aid stores it wants.
The deal that's going away
Walgreens agreed to buy Rite Aid in 2015 for $9.4 billion, or $9 per share, however, fears that regulators would scuttle the deal over its impact on competition resulted in a restructured agreement this past January that included the sale of up to 1,200 stores to Fred's Inc. (NASDAQ:FRED). In this revised deal, Walgreens Boots Alliance had agreed to pay Rite Aid between $6.84 billion and $7.37 billion, or $6.50 to $7 per share, depending on the final number of stores sold to Fred's.
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Despite this restructuring, the odds of an FTC blessing remained a coin-flip. According to Drug Channels, the top dispensing pharmacies in the U.S. hauled in two-thirds of U.S. prescription revenue last year, suggesting this market is already heavily consolidated among a few big players.
CVS Health (NYSE:CVS) was the country's largest pharmacy chain by market share last year, with its stores accounting for 14.8% of U.S. prescription revenue. Walgreens Boots Alliance was in second place with 13.8% market share, and Rite Aid was in fifth place with a market share of 4.8%.
If the deal had eventually gone through, Walgreens Boots Alliance would have ended up with about 19% U.S. prescription drug revenue market share across 11,000 stores filling roughly 1 billion prescriptions per year.
The new(est) deal
In May, Walgreens Boots Alliance and Rite Aid certified to the FTC that it had fulfilled regulators latest request for information, kicking off a 60-day window during which the FTC would have to decide if it would sue to block the deal.
That clock was set to expire on July 7, so the FTC scheduled a closed-door meeting with its current two members for Thursday, ostensibly to discuss if they should let the deal through.
Clearly, Walgreens Boots Alliance and Rite Aid doubted that would happen, because on Thursday Walgreens Boots Alliance announced it will pay Rite Aid a break-up fee of $325 million to cancel their merger.
Instead, Walgreens Boots Alliance is cherry picking the stores it wants to buy and handing over a pile of cash to Rite Aid in exchange for them. In total, Walgreens Boots Alliance will buy 2,186 Rite Aid stores and three distribution centers and Rite Aid will pocket $5.175 billion, plus the break-up fee. The two companies hope to close this newest deal in six months.
What's the take-away?
A hefty debt load because of prior acquisitions has given Rite Aid more than its fair share of headaches over the past decade, and an increasingly fierce turf battle over prices has crimped growth too. It's been a one-two punch that has led to inconsistent profit, and unfortunately this new agreement may not fully address its challenges. While it provides financing that sures-up Rite Aid's balance sheet, it doesn't eliminate the company's competitive disadvantages to CVS Health, Walgreens Boots Alliance, and others.
It seems that point wasn't lost on Rite Aid, either. Management did negotiate for the inclusion of an option that, if exercised, would allow it to piggy back on Walgreens Boots Alliances' purchasing power. The company has until May 2019 to exercise that option, but even if it does, there's no guarantee how big of a tailwind to profit that will be.
Perhaps Rite Aid will attempt to sell its remaining stores to another group. Private equity or a large company with an eye on entering the prescription drug market (eh-hem, Amazon.com) could be interested. However, that's purely speculation.
Overall, it appears to me that Walgreens Boots Alliance is the big winner in this new deal. Assuming it negotiated for stores in non-overlapping markets with attractive demographics, it may end up with the assets it had really wanted to buy anyway. The company expects the deal to be "modestly accretive" to adjusted earnings per share in the first full year after it's complete, thanks in part to $400 million in cost-savings and other synergies.
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