Deals

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

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.

Breaking Out
Wall Street analysts mused that Fred's could be involved in the Walgreens-Rite Aid divestiture process but didn't factor an acquisition into their estimates
Source: Bloomberg

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.

Bulking Up
Fred's is more than doubling its store count (and enterprise value) with the acquisition of 865 Rite Aid stores
Source: Company

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.   

To Your Health
Fred's CEO said this month that health care "is the key to our growth...our profitability, and the center of our business model." Personal health care is among the fastest-growing areas of consumer spending.
Source: Bureau of Economic Analysis

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). 

Satisfied?
Selling 865 stores to Fred's should be enough to soothe regulatory concerns about Walgreens's purchase of Rite Aid
Source: Bloomberg

This year hasn't been kind to merger arbitrageurs, but this is at least one situation that's ending on a high note. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net