Walgreens abandons Rite Aid bid, will instead buy nearly half of stores

Nathan Bomey | USA TODAY

Show Caption Hide Caption Did Walgreens just outsmart the FTC? Walgreens terminated its merger with Rite Aid, but despite leaving the deal behind, Walgreens will pay $5.175 billion in cash to buy 2,186 Rite Aid stores.

Corrections & Clarifications: Corrects an editing error to state that it was Rite Aid shares that fell 26.5% Thursday

Walgreens abandoned its deal to acquire drugstore chain Rite Aid and will instead buy nearly half of its smaller rival's stores for $5.1 billion after U.S. regulators raised antitrust concerns about the original plan.

The long-suffering deal's implosion preserves the three largest drugstore chains as independent entities, but the new agreement will still make Walgreens Boots Alliance, its official name, the nation's largest by number of locations, edging archrival CVS Health.

Consumer advocates gently welcomed the development, saying the original accord would have given Walgreens too much pricing power but cautioning that the new deal may still require oversight scrutiny.

"This merger would have led to higher prices," former FTC policy director David Balto said. "It's important to preserve three national competitors. That’s in essence what the FTC was saying."

Walgreens said Thursday that it would buy 2,186 Rite Aid stores, three distribution centers and inventory. Rite Aid investors reacted badly to the news, causing its shares to plunge 26.5% Thursday.

To be sure, the new deal must still pass regulatory muster, which could be stiff if officials suspect that Walgreens would have too much pricing power or bargaining leverage.

With the new agreement, Walgreens would have more than 10,200 U.S. stores, giving the chain opportunities for cost cuts and greater leverage in negotiation with landlords, health-care companies and vendors. CVS has more than 9,600 stores.

Rite Aid, which currently has about 4,600 locations, is selling stores primarily located in the Northeast, Mid-Atlantic and southeastern U.S.

As a result of the original deal's cancellation, Walgreens owes Rite Aid a $325 million breakup fee — a customary provision in major merger agreements to compensate the targeted company if a deal collapses.

The move also means that Rite Aid's previous deal to sell certain stores to drugstore chain Fred's, in an effort to assuage regulators, is off.

Walgreens CEO Stefano Pessina said the new deal would allow the company to make its stores more efficient, with a goal of wringing out $400 million in annual "synergies." That often includes cost cuts and purchasing improvements.

For Walgreens, the new accord is also significantly less expensive. The company's original deal was pegged at about $9.4 billion, but it was lowered to a range of $6.8 billion to $7.4 billion in January after the tie-up languished in limbo.

"It’s true to our original strategic aim," Pessina said. "Overall I view this deal as being more attractive than the transaction it replaces."

Walgreens shares rose 1.7% Thursday to close at $78.37, up $1.28.

But Rite Aid investors were experiencing the Wall Street equivalent of a panic attack, driving shares down $1.04 to close at $2.89.

Rite Aid said it had to ditch the original deal after regulators privately "led the company to believe that the parties would not have obtained FTC clearance to consummate the merger."

"It’s now clear we're going to continue as an independent company," Rite Aid CEO John Standley said, adding that he believes the company will be "more focused."

The deal gives Rite Aid the right to purchase generic drugs through Walgreens to gain the cost advantages it's otherwise relinquishing by shedding locations.

But Rite Aid is being pressured on several fronts, including reduced drug reimbursement rates and fewer prescription fulfillments.

Sales at Rite Aid stores open at least a year fell 3.9% in the quarter ended June 3, the company said Thursday. And the company's quarterly net loss widened to $75.3 million from $4.6 million a year earlier.

Meanwhile, Walgreens said Thursday that its net earnings rose 5.2% to $1.17 billion for the quarter ended May 31.

The new deal was designed to alleviate the FTC's concerns about the market overlap between Walgreens and Rite Aid.

Tad Lipsky, acting director of FTC's Bureau of Competition, said the agency had "thoroughly investigated the potential impact" of the originally proposed deal and several revised offers but that the companies "voluntarily withdrew."

Lipsky said the agency would review the new deal, as is typical.

"The FTC has made its mark here," Balto said. "They’re not necessarily going to roll over for Walgreens."

Mizuho Securities analyst Ann Hynes hailed the deal as "positive" for Walgreens because the it "removes a significant overhang," generates additional profits and will deliver cost savings.

Moody's Investor Service noted that the deal would result in less borrowing by Walgreens. Meanwhile, Rite Aid plans to use the proceeds to cut its debt in half.

Rite Aid is exiting South Carolina, Utah and Indiana, and will have one or two stores apiece in Mississippi, Georgia, Alabama, Maine, Rhode Island, West Virginia, Kentucky and Nevada. The company is also selling most of its stores in Colorado, Tennessee, Louisiana, Vermont, North Carolina and Massachusetts.

As part of the latest deal, Rite Aid agreed not to open any new stores in the locations where it's selling for two years.

The company said about 60% of the stores it will continue to operate have been recently remodeled to focus on "wellness," as drugstores increasingly attempt to offer healthcare services to customers.

Follow USA TODAY reporter Nathan Bomey on Twitter @NathanBomey.