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Fred’s poised to be chain drug player

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Deal to buy 865 Rite Aid stores paves way for WBA to complete merger

Though Fred’s name came up in the buzz surrounding the Walgreens-Rite Aid merger talks with the FTC, the Southeastern retailer’s move to buy 865 Rite Aid stores for $950 million in cash from Walgreens Boots Alliance (WBA) still was surprising.

Freds Pharmacy sign_featuredAfter all, not even two weeks ago, Fred’s reported poor third-quarter results (including a net loss) and announced plans to close 40 underperforming stores. That didn’t exactly make the company look like an expansion candidate.

Well, Fred’s and CEO Mike Bloom saw an opportunity and grabbed it.

In fact, Bloom said when announcing the deal that Fred’s has been “working for several months on integration plans” to enable a smooth transition for the Rite Aid stores. He also noted that Fred’s is “leveraging our world-class senior leadership team’s significant expertise in managing major health care acquisitions and integrations,” adding that the company put together this “highly experienced team” in 2015.

Before Bloom became CEO at the end of August, Fred’s already had been working to bring more of a pharmacy flavor to its discount retail stores.

Predecessors Jerry Shore and Bruce Efird drove initiatives to refocus more of the business on pharmacy and health care. Those efforts included boosting the percentage of the retailer’s stores with pharmacies as well as the acquisition of specialty pharmacy EntrustRx. And in July 2015 Fred’s said it retained global management consulting firm A.T. Kearney to help the retailer grow its pharmacy operation.

As a result of these efforts, more than half of Fred’s revenue now comes from pharmacy. Overall, the chain currently has 647 discount general merchandise stores, including 370 pharmacies, in 15 Southeast states.

With the addition of the Rite Aid stores, Fred’s will become the third-largest U.S. drug chain, with 1,235 pharmacies in its 1,512 stores overall. The question now is, where are these new stores located?

All Fred’s has said thus far is that the stores are in “highly attractive markets” and are “generally representative of Rite Aid’s pre-divestiture store performance with respect to both sales and EBITDA.”

“The proposed divestiture transaction, if approved, would establish Fred’s Pharmacy as one of the largest drug store chains in the United States, with significant presence in areas such as the South and on the East and West Coasts,” WBA stated Tuesday in announcing the Rite Aid store sale. “Specific locations of the stores to be divested will be announced upon FTC approval of the Walgreens Boots Alliance and Rite Aid merger.”

Analyst Brian Tanquilut and his team at Jefferies LLC have done some homework. In a research note Tuesday, he wrote, “Fred’s management stated that the acquisitions are located across the eastern and western United States. But since they did not provide much more detail than that, we’ve laid out the major metropolitan markets where Fred’s could add to its current presence and markets where they could expand their operations to as a result of WBA-Rite Aid controlling more than the 40% regulatory threshold.”

Tanquilut noted that Fred’s right now has no market presence outside the Southeast. “So based on management’s comments, we could see Fred’s picking up significant operations in California, Colorado, Florida, North Carolina and Washington in addition to bolstering their current market share in the Southeast,” he explained.

Check out the map below from the Jefferies report:

jefferies_freds-rite-aid_map

Source: Jefferies Equity Research, equity analyst Brian Tanquilut, Dec. 20, 2016.

 

The other question hanging over Fred’s purchase of the stores, given the company’s recent financial performance, is financing. Details have yet to emerge. All Fred’s has said so far is that Bank of America Merrill Lynch and Regions Bank have committed to provide financing, and A.T. Kearney has served as a strategic adviser for the transaction.

One thing looks like a good bet, though: Fred’s purchase puts WBA in a solid position to move ahead and complete the Rite Aid acquisition.

“We believe that today’s announcement of the proposed divestiture of 865 Rite Aid stores to Fred’s for $950 million in cash should be sufficient to appease regulatory competition concerns and eliminate concerns about WBA’s ability to close the Rite Aid deal,” Tanquilut said in his research note. “We believe regulators will view WBA’s proposed sale of 865 units to Fred’s as an acceptable solution to antitrust concerns, as the deal creates a larger, more viable competitor to WBA and CVS, and Fred’s management seems committed to keeping the stores open as opposed to closing stores and transferring Rx files, which was previously a concern of the FTC.”


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