Rite Aid Merger Tank: Lessons From Staples & Office Depot Merger Failure

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When pending mergers take too long to close due to regulatory reviews, it is not unusual for investors to get burned. That is now the case for investors who were banking on the acquisition of Rite Aid Corp. (NYSE: RAD) by Walgreens Boots Alliance Inc. (NASDAQ: WBA). While this merger might not be dead entirely, the reality is that the reaction has been bad enough that many investors are going to consider this proposed merger history.

Investors could have taken at least some historical lessons from the failed Office Depot, Inc. (NASDAQ: ODP) acquisition that was the dream of Staples Inc. (NASDAQ: SPLS). One lesson might be that failed mergers hurt, and the second is that they do not just immediately recover from the post-news sell-off.

An outright buyout of Rite Aid now looks a lot more complicated than it did a few months ago. Despite store dispositions, both drug store companies had maintained that they were planning to close on the acquisition. Now Rite Aid investors should expect $2 billion less than what was agreed to more than a year ago.

Both companies had agreed to a $9.00 per share buyout price. The new terms of the merger call for Rite Aid shareholders to receive per share a minimum of $6.50 and a maximum of $7.00. Another issue to consider is that the merger deadline has been pushed out six months (from January 27, 2017, to July 31, 2017) and could include the divestiture of up to 1,200 Rite Aid stores to gain regulatory approval.

Under the terms of the amendment, the parties have agreed to reduce the price for each share of Rite Aid common stock to be paid by Walgreens. The revised price will be a maximum of $7.00 per share and a minimum of $6.50. In addition, Walgreens will be required to divest up to 1,200 Rite Aid stores and certain additional related assets if required to obtain regulatory approval.

This merger seemed more or less as something that should have happened initially. Still, antitrust reviews under the Obama administration were more stringent than most investors had been used to. That’s why investors should still consider the risks of what took place between Staples and Office Depot.

When Office Depot merged with Office Max in late 2013, there was trouble in the land of office products. The new Office Depot combined with OfficeMax would have had combined revenue for the prior 12 months of approximately $17 billion. It then employed about 66,000 associates worldwide and served 59 countries with more than 2,200 retail stores and e-commerce sites.

Then in early 2015, Stapes offered to acquire Office Depot even before the Office Max acquisition was even fully integrated. That merger valued Office Depot at $11 per share, based on $7.25 in cash and 0.2188/1 Staples shares. With the acquisition of Office Depot, Staples said in early 2015 that the combined companies would have pro forma annual sales of approximately $39 billion.

The regulatory review process for Office Depot and Staples was rather long, and in 2016 the deal was called off. On last look, Office Depot shares were trading at $4.30 in a 52-week range of $3.01 to $7.91, and the consensus analyst price target is now down at $4.99. Staples shares are closer to $9.00, down from a December 2014 high of $18.00. That failed merger even ultimately cost Staples’ CEO his job, after 24/7 Wall St. had named him as a CEO that should be let go in 2016.

Sometimes it is hard to derive an exact lesson from prior mergers that blew up. Either way, the Rite Aid merger review has gone on so long that the investors had every reason to be nervous.

There was more to this Walgreens and Rite Aid merger than just integrating two pharmacy chains. Walgreens and Alliance Boots merged back in December 2014, and adding several thousand more stores was deemed as a hard swallow for regulators. Walgreens Boots Alliance has roughly 13,200 stores in 11 countries, as well as one of the nation’s largest global pharmaceutical wholesale and distribution networks of more than 230,000 pharmacies, doctors, health centers and hospitals each year in more than 20 countries. Rite Aid has nearly 4,600 stores in 31 states and the District of Columbia, and its fiscal 2016 annual revenue was $30.7 billion.

The exact formula for the merger price per share paid by Walgreens is based on how many (or few) stores will have to be sold or divested. Monday’s press release said:

Under the terms of the amendment, the parties have agreed to reduce the price for each share of Rite Aid common stock to be paid by Walgreens Boots Alliance. The revised price will be a maximum of $7.00 per share and a minimum of $6.50 per share. In addition, Walgreens Boots Alliance will be required to divest up to 1,200 Rite Aid stores and certain additional related assets if required to obtain regulatory approval. The exact price per share will be determined based on the number of required store divestitures, with the price set at $7.00 per share if 1,000 stores or fewer are required for divestiture and at $6.50 per share if 1,200 stores are required for divestiture. If the required divestitures fall between 1,000 and 1,200 stores, then there will be a pro-rata adjustment of the price per share. Walgreens Boots Alliance agreement to divest up to 1,200 Rite Aid stores represents an increase of up to 200 stores over the 1,000 stores that Walgreens Boots Alliance had agreed to divest under the terms of the original agreement.

As you have probably assumed, a failed merger usually hurts the acquisition target more than it hurts the acquirer. Rite Aid shares were down another 17% at $5.76 on Monday, versus $6.93 close on Friday. Its 52-week trading range is now $5.70 to $8.77. Rite Aid’s market cap is down to $6 billion. Walgreens shares were down just 0.3% at $81.26, with a 52-week range of $71.50 to $88.00. Its market cap is $88 billion.

There is a secondary view here worth considering as well. Fred’s Inc. (NASDAQ: FRED) was set to acquire around 865 Rite Aid stores for $950 million. It has been reported that this deal remains, but details over whether more stores would be acquired remains unfinished business. To put the Fred’s deal in context, it was originally expected that maybe just under 500 store sales would be needed to garner approval. Shares of Fred’s were trading up 2.7% at $14.50, in a 52-week range of $7.89 to $21.77. Its market cap is almost $$552 million.