Drug chains strategize after nixed Walgreens-Rite Aid merger

Walgreens Boots Alliance Inc. (WBA) and Rite Aid Corp. announced on June 29 that their merger is off, which goes to show you that nothing is certain in the world of retail mergers and acquisitions, especially with the U.S. government involved.

The long and somewhat tumultuous process of WBA’s proposed acquisition of Rite Aid, which began in October 2015, has finally come to an end.

Now, rather than a merger of the two companies, WBA has agreed to purchase 2,186 Rite Aid stores and three distribution centers for $5.175 billion in cash, exercisable through May 2019 (plus a termination fee of $325 million to Rite Aid).

Brian Owens, Kantar Retail

In addition, the previous arrangement in which Fred’s Pharmacy would purchase up to 1,200 divested Rite Aid stores (which would have transformed Fred’s into the third-largest U.S. pharmacy chain overnight) is now off, although Fred’s will receive $25 million as reimbursement for expenses associated with the terminated ­transaction.

All three retailers have expressed optimism about this new arrangement. Here is our initial read on the situation.

Is Walgreens done dealing?

The general sentiment WBA chief executive officer Stefano Pessina conveyed on the company’s third quarter 2017 earnings call was one of optimism. WBA believes the deal expands Walgreens’ store footprint and patient access, while bringing its U.S. store count to roughly 10,361 (compared with CVS Pharmacy’s 9,626, including locations in Target Corp. stores).

This makes WBA’s string of preferred-network deals with pharmacy benefit managers even more valuable, now that shoppers have increased access to Walgreens pharmacies.

However, the Rite Aid stores involved in this transaction will include underperforming locations, suggesting that WBA may close some of these slow-moving inventory doors if the cost to refresh them is too great, or if the cross-shop rates with competitive retailers such as CVS are too high.

Another possibility is that some of the newly acquired stores will provide WBA with test-and-learn opportunities. They could also be leveraged as health care centers, opening up WBA to more clinical partnerships across the U.S.

Now that the Walgreens-Rite Aid merger deal is off, WBA will turn its attention to internal development and cost savings — likely relaunching its loyalty program; building up beauty; and executing its ONE Plan focused on convenience, loyalty and care.

Additionally, the Retail Pharmacy USA segment just experienced its highest quarterly comparable-script growth in seven years, suggesting that WBA will continue to work toward the continued success of its strategic pharmacy partnerships and Medicare Part D services.

Since it is focusing on internal development and cost savings, we believe WBA will not do any more major front-store strategic moves for the next 12 to 18 months.

Where does Rite Aid go from here?

Overall, the new deal with WBA is good for Rite Aid. The retailer can shed some dead weight, get back to business as usual, pay off debt and focus on higher-performing stores. The prolonged uncertainty over the merger has hurt Rite Aid. Many insurance companies have excluded Rite Aid from their restricted pharmacy networks due to this ambiguity and the deals they already had with Walgreens.

Now, Rite Aid has an opportunity to get back on track and make a fresh start.

Expect Rite Aid Wellness format conversions to continue. Currently, 60% of Rite Aid’s remaining 2,337 stores are Wellness stores; Rite Aid now has the potential to convert the rest of its store base to that format. Overall, with a smaller store base composed of higher-performing stores, Rite Aid can be more targeted, personal and ­local.

Another aspect of the deal provides Rite Aid with a 10-year generic drug purchasing option as part of WBA’s Group Purchasing Organization. Rite Aid will receive wholesaler discounts on generic drugs, which will allow the retailer to lower drug costs.

Rite Aid says it will continue to focus on its EnvisionRx PBM, RediClinic and Health Dialog offering, now with increased financial flexibility. A lighter, nimbler Rite Aid with boosted morale is a good thing for the retailer and suppliers alike.

Fred’s prospects

On the surface, it may seem as if Fred’s was left out in the cold. The Federal Trade Commission expressed concerns over Fred’s ability to drastically increase its footprint and realistically compete with CVS and Walgreens.

With such a tall order off the table, Fred’s now has the opportunity to refine and execute its transformation strategy more mindfully. While they would have been an added bonus, CEO Mike Bloom says acquiring the Rite Aid stores did not define Fred’s strategy.

Bloom has communicated plans to continue full steam ahead with the transformation strategy, whose primary goals are increasing prescription comps in retail pharmacy, growing specialty pharmacy sales and driving front-store traffic.

A new partnership or collaboration involving Fred’s is not out of the question, since the retailer’s footprint remains small. Fred’s potential to provide a low-income health care solution exists, and it would be hugely beneficial to the retailer and its shoppers if the company is successful.

Expect Fred’s to get creative over the next six to 12 months as it looks for strategic partners to broaden its low-income health value proposition to more U.S. counties.

Brian Owens is vice president of retail insights at Kantar Retail. He can be contacted at [email protected].