By Garrick Brown, Vice President of Retail Research, Americas
In the past week there were a few things that happened… One of the biggest business events just happened today… the Dow Jones hit 20,000 for the first time in history. Meanwhile, news broke that the proposed Walgreen’s/Rite-Aid merger may be hitting some snags. While the rumor on the street for the past two weeks had been that this deal would be approved prior to last week’s Presidential Inauguration that clearly didn’t happen. The rumor on Wall Street now is that the FTC is not so sure about the plan to offload 865 stores to Fred’s in order to ease regulatory concerns. The question, apparently, has been whether or not Fred’s had the financial capacity to buy the divested stores. The fear, apparently, is whether or not this could turn out to be like the December 2014 Haggen/Safeway deal in which regional Pacific Northwest chain Haggen agreed to purchase and rebrand 146 West Coast Safeway stores (including the namesake banner as well as Vons, Albertson’s and Pavilions-branded stores). At the time, Haggen was a 18-unit chain and this deal basically saw their size increase sevenfold. Of course, by September 2015 Haggen was in bankruptcy court. Legal battles, accusations and recriminations have ensued but the long and short of it is that Haggen abandoned the stores and then sold to Albertson’s in March of last year. There are now just 15 stores that still have the Haggen branding.
Of course, Fred’s purchase of 865 Rite Aid stores for $950 million would leapfrog the Memphis-based chain into becoming the country’s third-largest pharmacy operator and it would more than double its store count and triple its annual sales. According to my pals over at Credit Intel/F&D Reports, the acquisition’s price tag is an extremely attractive 4.5x EBITDA. But the deal also has significant risks to Fred’s in that in order to finance the deal, Fred’s has arranged $1.65 billion in new financing and their pro forma debt to EBITDA upon close of the deal would grow to over 4X.
Fred’s would also need to invest in the infrastructure necessary to operate these stores. No list of divested locations has been shared publicly, but Fred’s is a regional Southeast player and it is believed that there are locations in this deal scattered across numerous markets. That means the need for distribution chain investment, not to mention infrastructure and technology platform investments that may be necessary.
Fred’s stock price had almost doubled since the initial announcement of their deal, reflecting the fact that Wall Street liked the idea but the reality is that there remain concerns as to whether or not the chain may be biting off more than they can chew and it is those concerns the FTC apparently is focusing on. That said, Alden Capital Group, an activist investor firm, has quietly acquired a 25% stake in Fred’s and the company is staying in there for now trying to make this deal happen before this Friday’s deadline.
Fred’s amended their financing deal yesterday to make it more attractive to regulatore. Original financing for the deal had Fred’s enter into a commitment letter for a $1.05 billion asset-backed loan (ABL) and a $600.0 million term loan. Under the amended letters, the $1.05 billion ABL will be increased to $1.20 billion while the term loan will be decreased by the same amount to $450.0 million. Basically, the total amount of financing has stayed the same (and the loans are still subject to the consummation of the Rite Aid acquisition), but basically Fred’s has put more assets up as collateral. Will this make the deal attractive enough for the FTC to finally approve? Who knows—most of us expected this to close a couple of weeks ago. I suspect yes, but anything is possible nowadays.
Here is the rub though, if this is not approved by Friday, Walgreen’s and Rite-Aid will have to go back to the drawing board. I suspect they will try again, but this process has already dragged on for 15 months. If the Fred’s deal doesn’t happen, Walgreen’s has indicated they have other potential buyers. The challenge for Walgreen’s will be one of being able to divest these locations in bulk—especially with 15 months already spent on the deal. Of course, one cannot rule out that perhaps a smaller transaction involving Fred’s (a more bite-size deal) and perhaps some sales to some of the other original suitors that were hovering about (Kroger, Albertson’s/Safeway) could eventually emerge as a Plan B.
The thing to watch is this… if the FTC kicks this to the curb over monopolistic concerns then I think the deal dies a la Staples/Office Depot. Walgreen’s and Rite-Aid just continue on as they are and we still have the same three horse race in pharmacy land. But that’s not what we are hearing as to the FTC concerns… at least, the Wall Street people, private equity guys and reporters that I am talking to. If the FTC just shoots this down over concerns about the divestiture of those 865 stores to Fred’s then it’s more a matter of what Walgreen’s wants to do with those stores. So the deal is shot down on those grounds, I would expect some Plan B to be proposed with all the parties taking another shot at it.
My personal feeling is this gets approved but perhaps I have been drinking a little too much of the Wall Street Kool Aid today with the Dow hitting 20,000. Then again, something else big happened in the past week I guess worth mentioning… we got a new administration… which is likely the driving force behind all this Wall Street exuberance.
That said, U.S. investors are excited about Mr. Trump’s plans for corporate tax cuts and for widespread deregulation. Those are bound to create a surge in the economy. Are there potential downsides? Of course, but these are the two things driving this optimism. But these very same investors also like predictability, transparency and credibility. They tend to nor be fans of “alternate facts.” That said, here is where the uncertainty comes in.
The policy changes will be coming fast and furious over the next 100 days or so. If the new administration can improve on those issues of transparency, credibility and predictability the chances of this Wall Street honeymoon continuing go up significantly. If not, it will be a bumpy ride ahead.
Here is a link to our newly released Q4 2016 USA National Shopping Center Report.
Check out our recently completed U.S. Macro Economic Forecast. You can check it out by clicking here.
Additionally, a couple of weeks ago we released a new retail report, Food Halls of America, as well as the first episode in an accompanying series of videos: Cool Streets: Food Halls of America Manhattan edition. If you would like to check out that report and video please just click here.
You can watch our webinar Clicks vs. Bricks: Why Cyber Monday is taking over Black Friday by clicking here.
Our Main Streets Across the World Report tracks high street retail around the world and breaks out the globe’s premier shopping districts by continent and average asking rent. It is an invaluable resource and you can access it by clicking here.
By the way, here are a few other links that you might also find useful as well:
You can access the 2016 North American Retailer and Restaurant Expansion Guide by clicking here.
Additionally, you can check out the Cool Streets of North America Report and accompanying video series by clicking here.
This post is commentary from the latest weekly edition of our Cushman & Wakefield Retail Newsline, which you can subscribe to for free by e-mailing firstname.lastname@example.org.
Garrick serves as Vice President of Retail Research for the Americas. He speaks frequently at industry events and has been a keynote speaker at symposiums, conferences and market forecasting events for groups like the Appraisal Institute, Urban Land Institute, CREW, ICSC and PRSM. He is also a member of Lambda Alpha International, an invitation-only land use society for those who are involved in the ownership, management, regulation and conservation of land, but also those who are involved in its development, redevelopment and preservation.