Fred's Inc. shareholders are bounding into the holiday season with a little extra cheer.
The Memphis, Tennessee-based retailer on Tuesday agreed to buy 865 drugstores from Walgreens Boots Alliance Inc. and Rite Aid Corp. for $950 million, a transaction that should help the two big chains win regulatory approval for their planned merger. But the deal is also a big win for Fred's, and investors liked it so much they sent the company's stock surging on the news: As of about noon Tuesday, the shares were up 75 percent and trading at $19.50 apiece.
Shareholders don't mind that Fred's -- whose enterprise value was less than $500 million as of Monday's close -- is taking on more than $1 billion of debt to finance the deal. That's in part due to the fact that the company is paying a multiple of roughly 4 times Ebitda, a steep discount to the nearly 13 times Walgreens is paying for Rite Aid. And on a per-store basis, the purchase represents a similar valuation to Target Corp.'s sale of 1,700 pharmacies to CVS Health Corp. in a $1.9 billion deal that closed last December.
Unlike most deals, this one was a pretty poorly kept secret. An analyst day scheduled for this month was postponed and management didn't allow a Q&A session on an earnings call the week before last due to a "pending transaction". And on that call, Fred's CEO Mike Bloom reiterated that growth in retail and specialty pharmacy was key. He wasn't lying: Fred's purchase will make it the third-largest U.S. drugstore chain.
Considering it's larger than the 500 store divestitures that Walgreens' CEO Stefano Pessina had estimated would be required to earn the green light from the regulators and that Fred's is a legitimate buyer, Tuesday's transaction should clear the path to a deal. Plus, if the Federal Trade Commission requires the sale of any more than the 865 stores, Fred's is already locked in to buy the remainder. Rite Aid's investors rightly cheered, sending the stock to its highest level since October 2015 (when the takeover was announced).
This year hasn't been kind to merger arbitrageurs, but this is at least one situation that's ending on a high note.
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