Taking Stock

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Out Of The Blue, Fred’s About To Enter Competitive, Overstored Northeast Market

For many months, trade analysts expected that Kroger would be the winning bidder for the hundreds of Rite Aid stores that the Federal Trade Commission (FTC) would mandate for divestiture by Walgreens Boots Alliance if it were to successfully complete the $9.4 billion acquisition of the Camp Hill, PA drug store chain first announced 15 months ago.

Not only would such a deal add to Kroger’s HBC, GM and pharmaceutical business, it would provide the industry’s largest pure-play supermarket operator with an entry into the Northeast, the largest remaining empty geography for the Cincinnati-based merchant.

Several of our Wall Street sources alerted us before Thanksgiving that Kroger was rethinking about moving forward, leaving an opportunity for another bidder to emerge.

When the smoke cleared and the curtain opened, Fred’s Inc., a regional drug chain based in Memphis, came away with the prize that would include 865 stores for $950 million in cash (about $1.1 million per store).

The proposed deal would more than double the size of Fred’s, which currently operates Fred’s 647 general merchandise discount stores located primarily in the Southeast that include 371 full-service pharmacy departments within its stores. Many of its stores are located in small towns.

Additionally, the deal requires Fred’s to buy additional stores if the FTC requires the divestiture of more than the 865 units.

While neither party would reveal the specific locations that were to be acquired before the merger is approved by the FTC, many of the overlapping Rite Aid and Walgreens stores are located in the Northeast. And that alone would give concern to how successful can any new operator be in the most overstored, competitive marketing area of the country.

“This will be a transformative event for Fred’s Pharmacy that will accelerate our health care growth strategy through our acquisition of 865 new stores located in highly-attractive markets,” Fred’s Pharmacy CEO Michael K. Bloom said. “We believe that this transaction will also create tremendous opportunities for both our new and existing front of store and pharmacy team members. We look forward to realizing the considerable benefits this transaction will bring to our customers, patients, payors, supplier partners, team members and shareholders.”

Bloom knows the Northeast well. For 20 years he served as a senior executive at CVS and prior to joining Fred’s in 2015 was president and COO of Family Dollar (which was acquired by Dollar Tree in 2014).

Not only will Fred’s be competing against larger and superior operators CVS and Walgreens, it will likely end up with the stores that Walgreens deemed inferior to the overlapping stores that the Deerfield, IL chain will keep. Additionally, the competition from other high-volume HBC, GM and prescription retailers not in the drug channel (i.e. Wal-Mart, ShopRite, and all the AUSA banners) will certainly be a lot different from the competitive landscape in Hueytown, AL.

Fred’s will also have to deal with other challenges such as logistics and culture integration. Part of the agreement calls for Fred’s continue to operate the stores under the Rite Aid banner for two years and would continue to employ all store associates and certain field and regional associates related to operations.

That alone might create some short-term stability, but remember it’s only been a couple of years since Rite Aid has progressed to “sea-level” status and it is still a distant third to drug chain leaders Walgreens and CVS. The integration of 3,600 Rite Aids will likely be easier for Walgreens than it will be for Fred’s to absorb 865 stores (and has never operated on either the East or West Coasts).

It’s a big opportunity for the company that began as a single store in Coldwater, MS in 1947. That opportunity comes with big risks.