WHAT IT MEANS AND WHY IT'S IMPORTANT — A miniature version of the spike in stock market activity that followed speculation about the prospects of a Walgreens-Rite Aid merger happened on Drug Store News' website as a quick writeup about the potential deal became the most-read story on the site.
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But for all the buzz that Credit Suisse analyst Edward Kelly created with his report, a Walgreens-Rite Aid merger appears pretty unlikely on closer inspection.
For one, neither company has made any noise about the idea of a merger and, pursuant to respective company rules, neither has offered comment to news media. All in all, it's starting to sound like a repeat of when analysts from Susquehanna Financial Group offered similar speculation in November.
On top of that, a merger wouldn't make a lot of sense for either company, even considering Kelly's view that it would give Walgreens more leverage in its continuing dispute with Express Scripts.
Kelly himself put the probability of a deal at one-in-three, writing, "Ultimately, a deal could carry too much risk for a traditionally conservative Walgreens." Walgreens has historically guarded its credit rating very closely, and an all-cash deal to buy Rite Aid for $8 billion would probably reduce that rating to just above junk status, he wrote. In addition, unlike CVS and Rite Aid, Walgreens has generally pursued organic growth rather than large-scale acquisitions, and Guggenheim Partners analyst John Heinbockel noted that its relative lack of experience with large-scale acquisitions could hinder a deal with Rite Aid; even its 2010 acquisition of Duane Reade doesn't count, considering that when it bought that chain, it retained the Duane Reade brand rather than converting the stores. Walgreens' historical aversion to large-scale acquisitions is due in part to being burned in the 1980s by its purchase of 66 Medi Mart stores in New England, when it had to close all but a handful of them, as former CEO Jeff Rein said in a conference call Monday with Kelly. And the expenses associated with buying Rite Aid wouldn't stop with the acquisition itself: As noted by Heinbockel, Walgreens would have to spend a further $1 billion to $2 billion to convert the Rite Aid stores, and Kelly wrote that it would have to close 250 to 350 of them to satisfy antitrust regulations.
And for all its problems with debt and underperforming stores, Rite Aid isn't exactly screaming for salvation, either. In the conference call, Rein noted that when CVS bought more than 1,000 Eckerd stores in the South, those stores were already ailing, and Walgreens' comps were "through the roof" as a result, but that soon changed when CVS converted the stores and improved them.
But Rite Aid is a different story. The company has lately pursued organic growth, particularly through its Wellness+ loyalty card program, launched nationwide in April 2010, and the conversion of its stores to the new Wellness format, in addition to closing underperforming stores. Not only has Wellness+ resulted in strong sales growth for Rite Aid, but it and the Wellness stores indicate that Rite Aid is interested in growing as a company rather than making itself look like an attractive acquisition target.
A Walgreens acquisition of Rite Aid is certainly possible — nobody can predict the future, after all — but it doesn't seem like it's going to happen any time soon.