Analyst: New deal is ‘good compromise’ for Walgreens, Rite Aid — if FTC allows it
The news that Walgreens is to scrap its $9.4 billion merger with Rite Aid is unsurprising. The glacial pace of the Federal Trade Commission investigation and increasing signals that the federal government would disallow the merger have forced a rethink.
In some ways, the process so far has been a colossal waste of resources and effort. Walgreens has to pay out a $325 million termination fee to Rite Aid, and all parties — including Fred's, which was due to acquire some Rite Aid stores — have invested time and money with very little to show for it.
We are highly critical of the FTC's involvement in this process, just as we are of the body in general. When it comes to retail matters, we believe it to be both inefficient and ineffective. Its previous decisions, such as the instance that Dollar Tree disposes of Family Dollar stores during acquisition, and that Albertsons-Safeway sells off stores during their merger, have resulted in failure. In both cases, the spin-offs, designed to provide more choice to consumers, went bankrupt and ended up back in the hands of larger players. For us, this underscores the government's complete lack of understanding of how the retail market works in practice — something we believe was at play in the case of Walgreens.
Fortunately, Walgreens and Rite Aid have taken a pragmatic approach and replaced the merger with a deal under which Walgreens will buy 2,186 Rite Aid stores, related distribution assets, and some inventory for $5.175 billion. While this will still be subject to FTC scrutiny, it will, at least in theory, be easier to gain approval because it avoids the dilution of store competition in some markets and leaves Rite Aid as a viable player in the pharmacy space.
For Rite Aid, the deal is a good one. The proceeds of Walgreens' payment will allow it to reduce debt and restore its balance sheet to health. The company's first-quarter results, which were also released today, show the imperative of doing this: the $109 million interest payment dragged it down to a net loss of $75.3 million — an unsustainable position.
The question, of course, is how Rite Aid will survive as a smaller entity. After the deal, the group will have 2,337 stores — around half the number it has now. This will be punishing on economies of scale, especially for a company that is already struggling to turn a profit even before interest payments are taken into account. The answer lies in the agreement with Walgreens, which will allow Rite Aid to become a member of Walgreens Boots Alliance's group purchasing organization. In our view, this will be highly beneficial and will allow Rite Aid to improve pharmacy margins drastically.
For Walgreens, the deal allows it to boost both the top and bottom lines at a time when growth is harder to come by. In our view, there will be some near-term benefits, but most of the synergistic savings and improved turnover will accrue over a period of three years. The costs of converting stores to the Walgreens format should, by and large, be neutral thanks to the improved margins Walgreens brings, and the uplift in sales from the stronger brand and improved store format.
In our view, while the deal is not the deal of choice for either Walgreens or Rite Aid it is a good compromise that brings benefits to both parties. Ironically, it is also one that means Rite Aid will effectively become a part of Walgreens network, albeit with a degree of operational and managerial independence. Of course, all of this remains subject to approval and all eyes now turn to the FTC for its decision on this latest move.
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Walgreens cancels deal to buy Rite Aid
Walgreens Boots Alliance has announced a new Rite Aid deal, ending its nearly two-year quest to acquire the Camp Hill, Pa.-based drug store chain. The divestiture agreement with Fred's Pharmacy, whereby Fred's would buy 865 Rite Aid stores, is also terminated.
The move comes after Walgreens has struggled to win approval of the deal from the Federal Trade Commission. Under the new agreement, Walgreens will acquire 2,186 of Rite Aid's 4,523 stores for $5.175 billion in cash. Also, Rite Aid will receive a $325 million termination fee.
"For Walgreens, this is potentially a good deal, gaining them expanded prime store presence, but without a lot of the overheads and challenges that come with taking over an entire company,” commented Maulik Bhagat, a managing director in the healthcare practice of AArete, a global consultancy. "It will allow the company to drive significant synergies through their operations, supply chain, etc. And it should allow Rite Aid to focus internally and look at ways to get back to profitability."
The 2,186 stores included in the new agreement are primarily located in the Northeast, Mid-Atlantic and Southeastern regions of the United States. Three distribution centers are included in the agreement, with locations in Dayville, Connecticut, Philadelphia and Spartanburg, South Carolina. Under the terms of the agreement, Rite Aid will provide certain transition services to Walgreens for up to three years after the closing of the transaction.
"While we believe that pursuing the merger with WBA was the right thing to do for our investors and customers, this new agreement provides a clear path forward and positions Rite Aid as a strong, independent, multi-regional drugstore chain and pharmacy benefits manager with a compelling footprint in key markets," said John Standley, chairman and CEO of Rite Aid. "The transaction offers clear solutions to assist us in addressing our pharmacy margin challenges and allows us to significantly reduce debt, resulting in a strong balance sheet and improved financial flexibility moving forward."
The initial closing of the new transaction is expected to occur within the next six months. Upon closing, Walgreens will begin acquiring the Rite Aid stores and related assets on a phased basis over roughly six months, and intends to convert acquired stores to the Walgreens brand over time.
“This new transaction extends our growth strategy and offers additional operational and financial benefits,” Stefano Pessina, executive vice chairman and CEO of Walgreens Boots Alliance, said. “It will allow us to expand and optimize our retail pharmacy network in key markets in the U.S., including the Northeast, and provide customers and patients with greater access to convenient, affordable care."
Walgreen and Rite Aide
Why the BIG concern about this acquisition when not a word is being said about Amazon and Whole Foods?? Okay, grocery is new segment, but still retail. Amazon uses the revenues from AWS to under cut retailers pricing. Yes they have good technology and returns policy and prime deliver but seems like unfair competition to me. Hard to compete against someone who doesn't need to make a profit.
CEO Spotlight: Chris Homeister, The Tile Shop
With home remodeling and housing starts on the rise, The Tile Shop is in a sweet spot. The specialty retailer of manufactured and nature stone tiles, which reported a 8.8% increase in net sales and a 4.9% increase in same-store sales for its first quarter, displays its collections in a showroom-like environment that includes full-room tiled displays and a design studio where customers can utilize 3D renderings to visualize their design ideas.
Chris Homeister joined The Tile Shop as COO in October 2013, and was named president and CEO in January 2015. Previously, he served as the general manager and senior VP of Best Buy's entertainment business group.
The Tile Shop has flourished under Homeister, who has presided over a turnaround that included the application of more analytical-based decision making to its business model. He also has devoted more resources to training associates, increased the company's focus to better serve the professional customer, and brought a more strategic approach to new store growth.
CSA spoke with Homeister about The Tile Shop and its plans for the future.
How is The Tile Shop positioned in the marketplace?
The Tile Shop has a unique retail offering that caters to both the trade professional and to the general consumer who is looking to update their tile options. Our trade professionals include general contractors, interior designers, flooring installers and customer home builders.
Tell us about the changes you've implemented since becoming CEO.
I’ve focused my efforts on three areas: developing our people, implementing new programs for the professional consumer and strategic store growth – all of which contributed to a dramatic improvement in financial performance.
Many initiatives were aimed at encouraging the same type of entrepreneurship that fueled the company’s growth in its early years as well as improving the customer shopping experience.
How are things going?
Our initiatives are working well: Between January 2015 and June 2017, we’ve opened 23 new stores, comparable store sales increased in an excess of 7% each year, and our share price has more than doubled.
Further, employee turnover has significantly declined and new store financial performance has improved dramatically.
What are your key priorities going forward?
This year, The Tile Shop is focused on expanding our brand to additional key markets, such as the Southwest, to inspire home owners and professional contractors alike to realize their home design dreams.
Additionally, we will also continue to build upon our success with improving e-commerce shopping experience, as well as finding unique ways to showcase our tile offerings via innovation and technology to further enhance our customer experience.
In your first quarter, turnover of sales associates was down about 25% from a year ago and nearly 50% from two years ago. How do you explain this — and why is it important?
Over the last couple of years, we’ve placed a significant emphasis on ensuring our sales associates are growing and developing by enhancing product knowledge, sales skills, expanding our sales career path, and leadership development among our current workforce. Developing great people is at the core of our business, and is the key element that has been driving our success.
I’ve also made it a personal priority to establish one-on-one relationships with store managers at each of The Tile Shop’s 129 current stores. And I personally speak to each new store manager before she or he is selected to lead our store. The customer is at the center of everything that we do, and I want to ensure that we have leaders in our store that share this same vision.
Through these initiatives, The Tile Shop has a created a class of tenured, motivated leaders at the store level, who have the skills and confidence to provide an exceptional customer experience and just as importantly recruit sales associates and designers to the store that make this vision come alive each and every day. Further, a pipeline of talent is being readied to step into new leadership roles as the company expands.
In a challenging retail environment, The Tile Shop is thriving. What are key factors in the company’s success?
In the first quarter of 2017, we reported record sales and profits. And we’ve continued to see these record numbers due to our effectiveness of consistently providing a high customer service level, which is certainly a key to our high average order and overall satisfaction.
Additionally, our Pro business has never been stronger, where we are viewed as a trusted partner with our professional customers at each store location.
How does the sales mix break down between regular homeowners and professionals?
Business to consumers accounts for about two-thirds of our business. Trade, or B2B, accounts for approximately one-third.
Is online a priority in your market niche?
More than 90% of our customers visit our website before, during and after their shopping experience with The Tile Shop. This is exactly why we’ve made significant improvements to our website over the last several years including the launch of an innovative new design tool called, Design Studio, allowing both professionals and general customers to customize their room design using The Tile Shop products.
We’ve also improved product pages and design content so it’s easy for customers to get inspiration for their next tile project.
What is the average store (showroom) size?
Size varies based upon location, but 14,000 sq. ft. is our new average showroom size.
How many new locations will the company open in 2017?
We will be opening approximately 12 to 15 stores in 2017, as well as entering into a new priority market later this year.
What type of locations do you prefer?
Locations are determined by many factors, including demographics, proximity to competition and existing stores, distribution centers, etc. We are opening both strip center, free standing, and also in urban locations – most recently in Atlanta (Buckhead), and Washington, D.C.
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