Rite Aid: Take Over Target for Walgreen?

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Rite Aid

U.S.’s third largest drug retailer Rite-Aid‘s (NYSE:RAD) stock jumped 7% on Monday after Analysts at Susquehanna Financial Group speculated that it may be a potential takeover target of Walgreen (NYSE:WAG), U.S.’s largest drugstore chain. Walgreen crossed 20% market share of retail prescriptions filled in the U.S. last quarter and is locked in a contract renewal dispute over reimbursements rates with the leading Pharmacy Benefit Manager Express Scripts (NYSE:ESRX) and stands to lose a large part of its $5 billion prescription business in 2012.

After its previous acquisitions of Duane-Reade and drugstore.com, will it now look towards Rite-Aid to strengthen its prescription market share?

See our complete analysis of Rite AidWalgreen

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PBM Consolidation Prompting Retailer Consolidation

Walgreen hit a roadblock with Express Scripts this year, after the two failed to renew their contract for 2012 despite several attempts. Walgreen refused to accept the reimbursement rates offered by Express Scripts and maintained a hard line stand not to accept terms similar to Express Scripts even from other players like Medco (NYSE:MHS). The dispute threatens to cost Walgreen a large part of the $5 billion business starting January (~90 million retail prescriptions).

Even though Walgreen hopes to bring the prescription revenue loss in 2012 down to $3 billion, it may be too optimistic. In the absence of a settlement, most of the 90 million prescriptions may land in the open market, benefiting Walgreen’s competitors CVS Caremark an Rite-Aid, as Express members look for new pharmacies to serve their needs.

To add to the challenges, U.S.’s two largest PBMs Express Scripts and Medco are attempting to merge, pending FTC review, which raises questions about the implications for Walgreen if Express Scripts gains antitrust clearance and folds in Medco next year, which could also stop doing business with Walgreen. Such consolidation would significantly increase their negotiating power in deciding reimbursement rates with the drug retailers and may prompt likewise consolidation among the drug retailers like Walgreen as well.

If Walgreen Acquires Rite-Aid

Walgreen’s prescriptions business has been growing ahead of the industry and crossed 20% last quarter with addition of 2,000+ stores and Duane-Reade and drugstore.com acquisition. Yet, its share is expected to decline in 2012 as a result of its dispute with Express Scripts, which does not appear any close to a resolution. Walgreen targets an organic store growth of 2.5-3% going ahead and may look towards Rite Aid, which occupies 7-8% prescription market share as a potential acquisition to reclaim and further grow its market share in the prescription business.

We have a $1.38 Trefis price estimate of Rite Aid stock, which is about 15% ahead of the current market price.

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