Merger Arbitrage Blog

Walgreens-Rite Aid Merger Roller Coaster Analysis

Last Friday on the 20th Jan, many investors were waiting for the FTC to give their final blessings to the long awaited merger between the 2nd and 3rd largest pharmacy chain stores in the U.S., anticipating that the outgoing FTC commissioners would want to give a decision before the Trump administration comes in.

But sometimes the “gods of investing” still managed to surprise us. I would be lying if I say I wasn’t shocked by the negative news that came during the morning. In fact, on the prior day, I had taken a small position of 300 shares at about $8.60, thinking to earn a bit of dough. Walgreens-Rite Aid merger is one of those mergers with twists and turns that sparked my interests but I never had enough time to investigate the merger in depth and convince myself to invest heavily into it. I was also full of Syngenta shares at the moment so I gave Rite Aid and lots of other merger opportunities a miss throughout this 3 months.

Media had overwhelmingly supported the idea that the merger is likely to be approved by end of January following news that an agreement with Fred’s to divest 865 Rite Aid stores had been confirmed. This agreement cemented the chances that the FTC will approve the merger.

New York Post had been reporting that the deal is going to close but the post had not been entirely accurate during the merger’s news reporting…

Mlex chipped in too, but they are off the mark this time though…

CTFN was also caught by the hype…

The DSN poll shows that 81% of 200 DSN readers thinks that merger will be approved before Trump’s inauguration day or after. Only 19% thinks that the merger will not be approved.

So now after the news that unnamed sources saying that FTC is not convinced of the divestiture plan broke out, Rite Aid had been down up to 20% at one point and ended down 13% by the end of trading.

Now, we have to analyse if investing in the merger is still a good choice. Obviously the spread is big but in my opinion not big enough if the merger was to fail. It seemed like investors are factoring additional time for Walgreens to get FTC approval, possibly till March or even later.

There is little information now regarding the position of FTC whether they are leaning to approval or rejection. Walgreens is also not giving any information so we can only guess.

I proposed that there are two possible scenarios or a combination of both:

1. FTC is not happy on the number and/or locations of the store divestitures.

2. FTC is not convinced Fred’s can absorb the stores and compete effectively.

There are news that Walgreens, Rite Aid and Fred’s had been working on the transactions long before the announcement in Dec 2016. I tend to believe this is true because the FTC process allows discussion on remedies before the parties submit the final plan. This will save the time and work on merger investigations.

According to the New York Post, CVS met FTC officials to convince them that the merger should not be approved. David Denton, CFO of CVS, said in public that the deal with Fred’s is fraught with danger.

The protest from CVS, the no.1 pharmacy chain in U.S. may have sowed doubts into the FTC. FTC is reminded of the Haggens deal which ultimately went bankrupted after buying divested stores from Safeway. Fred’s, although much bigger than Haggens, is still absorbing more than 1 times it’s current store count.

I believe that the Walgreens-Rite Aid deal will be delayed but ultimately will be approved.

Walgreens is selling the 865 stores cheaply to Fred’s, a little bit more than $1 million per store. At this price, Fred’s can have a better chance to make the acquired stores successful. With the stores, Fred’s will become the 3rd largest national pharmacy chain stores, replacing Rite Aid. Fred’s team, many coming from Walgreens and CVS, will have no problems integrating the new stores.

Financing from banks for the deal had been committed but the FTC may want Fred’s to submit plans to strengthen their balance sheet via more equity sales. This maybe part of the reason for the delay to the approval of the merger.

Another reason would be the time needed by FTC to ensure competition is conserved by the store sales. Walgreens only submitted the plans around end of Dec and one month may not be sufficient time to process and test all the information.

Some analysts remained confident of the deal:

Updated: January 23, 2017 — 3:54 am

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