Walgreens, Rite-Aid set for massive merger

The world’s largest pharmacy retailer – Walgreens Boots Alliance – is set to swallow up the US’ third largest pharmacy chain in a deal which will create a 13,000-strong store network across the country.

The deal will cost Walgreen US$17.2 billion, but is expected to result in $1 billion in annual synergy savings for the combined entity, largely offsetting the premium Walgreen will be forking out for the purchase.

Analyst Neil Saunders, CEO of Conlumino, describes the deal as “logical on several levels”. Aside from the synergistic savings, there is little overlap of the two retailers’ store bases, meaning Rite Aid will allow Walgreens to grow its presence and penetration immediately. “Certainly there are some city locations where duplication may result in one branch closing, but these are exceptions rather than the rule,” said Saunders.

Furthermore, changes to the US healthcare system under The Affordable Care Act have resulted in scale becoming a much more important consideration for health providers in order to cope both with the volatility of the industry and the rationalisation and cost savings necessitated by the federal government.

“While Walgreens is not without scale, this deal gives it considerably more muscle, especially in the light of rival CVS’s recent decision to buy Target’s pharmacy network.

“From the perspective of Rite Aid this is a very sound deal and a positive outcome for a business that has struggled to keep pace with its two larger rivals.”

Saunders says Rite Aid has a poor track record on the scale front, with a mere 11 new store openings this year being the highest number since 2010.

“Moreover, with 40 planned store closures this fiscal, the net number of stores will actually reduce – a continuation of a trend that has seen store numbers fall by 489 over the past seven years since the acquisition of the Brooks Eckerd chain. Such a position is untenable in the current market.”

In the absence of new store growth, Rite Aid has focused instead on making existing stores more productive. At the front end of its operation this has been through the Genuine Wellbeing format refresh which creates a more engaging and enticing shopping experience with enhanced levels of customer service.

“In our view, this is something that Walgreens will be able to assist with, especially through its strong stable of brands including Boots No 7 cosmetics,” said Saunders.

However, he believes it is in the creation of a more integrated healthcare provider that Walgreens has most to offer, especially as this is an area in which Rite Aid has been playing catchup.

“To be fair, the company made a good start with its RediClinic acquisition, which initially consisted of walk-in clinics in metropolitan areas of Texas, but has since been rolled out to more markets, including Seattle, Philadelphia and Baltimore-Washington. Some 50 new openings are planned for the current fiscal year, bringing the total to over 100. However, this is some way below the clinic numbers that CVS (975) and Walgreen’s (430) plan to open across their current fiscal years.”

Walgreens, Rite Aid will also stand to benefit from Rite Aid’s recent acquisition of Pharmacy Benefit Management firm, EnvisionRx. With its customer base of over 21 million members across the US, this should help drive retail traffic through the combined chain’s pharmacy network.

Saunders says the acquisition is not without its risks.

“The first one of these is regulatory approval. Despite the fact that there is not enormous overlap between the two chains, this is a major act of consolidation in a politically sensitive market. As such the FTC will examine the deal closely; and given its current slowness on the Staples merger – a part of the market far less sensitive than pharmacy – Walgreens could well have to wait some time before getting the green light.

“Another risk is that Walgreens Boots Alliance is biting off more than it can chew. While the integration of Walgreens and Boots has gone well, the company is still in the process of merging and this latest deal with add another layer of complexity into the mix. That said, CEO Stefano Pessina has an excellent record of making deals work, and there is no reason why this should prove to be an exception,” concluded Saunders.

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