Here’s Why We Think Walgreens Might Consider Acquiring Rite Aid

by Trefis Team
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Walgreens (NASDAQ:WBA) and Rite Aid (NYSE: RAD) have been hitting the headlines lately, owing to reports that the former, the largest pharmacy chain in the US, might by buy out the latter, the third-largest. Last year, Walgreens completed a merger with Alliance Boots, a British pharmacy chain, to create a chain spanning more than 12,000 stores in 25 countries [1]. Speculation about the Rite Aid acquisition started surfacing when Stefano Pessina, the billionaire investor who engineered the Walgreens Boots Alliance deal and currently the acting CEO of WBA, said that he could imagine doing more deals in the United States as Obamacare shakes up the country’s healthcare system.

However, this is not the first time such rumors have been around about this acquisition. Back in 2012, Rite Aid’s stock price jumped about 10% in a single day on similar reports [2]. But, this time around, there are more reasons supporting the  case. Let us take a look at some of those reasons below.

View our analysis for Walgreens

Acquisition Will Extend Walgreen’s Lead Over CVS As The Largest US Pharmacy Chain

As of November 30, 2014, WBA owned more than 8,300 stores in the US, more than CVS Health‘s (NYSE:CVS) 7,800 stores (as of February’15). Rite Aid’s more than 4,600 stores will provide a significant boost to WBA’s reach across the Unites States, though an overlap in the territories covered by the two chains might result in the closure of some Rite-Aid stores. This also falls in line with WBA’s strategy of further broadening its pharmacy, health and wellness services as Rite Aid has also been putting efforts into positioning itself as a health and wellness expert through its Wellness+ program. Additionally, Walgreens sales per square foot is about 54% (or $300) above that of Rite Aid [3]. By replicating some of its success (if not all) in Rite Aid’s stores, the company stands to unlock additional value for its shareholders. The total size of the opportunity, that is if WBA can generate the same sales per square foot from Rite Aid’s stores as it does in its own stores, stands at $12.5 billion.

Will Help Reduce Dependency On Pharmacy Benefit Managers

WBA, due to the nature of its business, has a higher exposure to risks arising from low reimbursement rates (explained here in detail). Its competitor, CVS, better manages this problem as it has a PBM business of its own. PBMs process prescriptions and use their scale to negotiate prices with drug manufacturers and pharmacies. While some of the savings generated from negotiations are passed on to customers, some of it becomes the PBM’s earnings. This dependence on an intermediary increases costs for WBA as PBMs squeeze out the already low reimbursement rates for optimizing their profit.

Rite Aid recently acquired EnvisionRx, a national pharmacy benefit management (PBM) company to help face these issues. By acquiring Rite Aid, Walgreen can mitigate the reimbursement rate risks as well as improve its margins on prescription drugs by saving on the PBM’s margin. There are several other synergies that we think Rite Aid might me able to realize due to its acquisition of EnvisionRx, explained here. Through an acquisition of Rite Aid, WBA stands to benefit from all of these synergies.

Conclusion

Considering the company’s history of growing through acquisitions, such as those of Duane Reade and Drugstore.com, it is likely that Walgreen will take another step in the same direction. This will not only help the company take advantages of the good times in the healthcare industry (as healthcare expenditures rise and ObamaCare expands Medicaid coverage), but also places the the company in a better position to manage headwinds such as lower reimbursement rates. Considering a hypothetical post-acquisition scenario, we will, in another article, quantify how benefits arising from this acquisition will impact WBA’s stock price.

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Notes:
  1. Walgreens News Release []
  2. Banking on a Walgreen-Rite Aid merger []
  3. Seeking Alpha Report []
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