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What a Rite Aid Buyout From Walgreens Would Mean for the Drugstore Industry

By Dan Caplinger - Oct 27, 2015 at 6:02PM

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Reports that two major U.S. chains will combine could have major ramifications for investors and consumers alike.

Image: Rite Aid.

During the financial crisis, Rite Aid (RAD -4.77%) came close to failing entirely, with massive losses stretching its debt-encumbered balance sheet to the brink. Yet the drugstore chain made an impressive recovery, and it now appears possible that Rite Aid shareholders could have the happy ending they've long waited for. Reports from The Wall Street Journal and other sources indicate that rival Walgreens Boots Alliance (WBA -2.39%) is apparently close to making a deal to buy Rite Aid, with some citing that a transaction could be worth about $10 billion. In response, Rite Aid stock soared more than 40% on Tuesday, and shares of Walgreens also rose 6% as investors consider the key benefits of such a combination. Let's take a closer look at what's known about the buyout and what it could mean both for the two players and industry leader CVS Health (CVS -1.42%).

What a deal would look like
At this point, the exact terms of a Walgreens-Rite Aid deal aren't entirely known, but sources seem adamant that a final agreement could come as soon as Wednesday, which coincides with the scheduled release of Walgreens' third-quarter financial report. The $10 billion estimate comes from putting a typical premium on where Rite Aid stock closed Monday.

What does seem likely at this point is that if Walgreens and Rite Aid were to combine, the two companies would have to work together in order to divest some of their total assets. Walgreens already has more store locations in the U.S. than any other drugstore chain, and combining the two networks would give it about a 5,000-store advantage over CVS Health. In particular, in several key regions of the U.S., Rite Aid and Walgreens have been the two main competitors, which could require concessions that would give CVS or another drugstore chain an entry into those markets.

Image: Walgreens.

Nevertheless, a Rite Aid-Walgreens deal could have a number of positive impacts on the combined company. Synergies in various areas of their businesses could produce considerable savings on expenses, and a larger company could be able to handle compliance and regulatory requirements from various healthcare laws, especially those connected with the Affordable Care Act.

Indeed, other parts of the healthcare sector have already seen considerable amounts of consolidation. Pharmacy benefits management companies have gotten a lot of attention both from drugstore chains like CVS and Rite Aid and from other industry players like health insurance companies. Health insurers themselves have also gotten into the mergers and acquisitions act, as the potential gains from consolidation in simplifying operations have become increasingly clear in light of the ACA and its requirements. In anticipating potential cuts in reimbursements and other payments from federal healthcare programs, deals like a Rite Aid-Walgreens merger can help build bargaining power that will become even more important in the future.

Will a deal go through?
Antitrust regulators will have to approve a merger between Walgreens and Rite Aid, and there will be obvious obstacles. Probably the biggest question that regulators will have to answer is whether they are comfortable with the idea of having two major drugstores in the U.S. market. On one hand, creating a duopoly doesn't seem to be consistent with the stances that the Federal Trade Commission has taken in the past in other industries. Yet with major broad-line retailers, grocery store chains, and other outlets boasting pharmacy operations of their own, one interpretation of antitrust law would suggest that combining Rite Aid and Walgreen wouldn't necessarily have a chilling effect on competition overall.

All in all, if a Rite Aid deal happens, it will mark a fitting end for investors who stuck it out through the tough times in 2008. Moreover, given some of the uncertainties that the smaller drugstore chain faces with continuing debt challenges and other obstacles to unfettered growth, Rite Aid might well appreciate the chance to join forces with one of its two larger rivals rather than having to come up with ways to catch up with both of them.

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Stocks Mentioned

Rite Aid Corporation Stock Quote
Rite Aid Corporation
$7.58 (-4.77%) $0.38
CVS Health Corporation Stock Quote
CVS Health Corporation
$93.20 (-1.42%) $-1.34
Walgreens Boots Alliance, Inc. Stock Quote
Walgreens Boots Alliance, Inc.
$41.18 (-2.39%) $-1.01

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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