It’s been a good week for Rite Aid Corporation (NYSE:RAD) shares, as talk of a buyout by bigger rival Walgreens Boots Alliance Inc. (NASDAQ:WBA) have surfaced… again. All told, RAD stock is 10% higher than last week’s close, though at $8.23 RAD is still well below the suggesting per-share acquisition price.
It’s hardly a done deal, however. While most RAD stock owners — not to mention holders of WBA stock — say they’re keen on a deal that would unite the two drug store chains, antitrust concerns are leaving many investors wondering if a merger of Walgreen and Rite Aid is simply a pipe dream.
So how’s all this apt to shake out with Department of Justice’s antitrust division?
Why the DOJ Might Allow a Merger of Rite Aid & Walgreen
If it all seems a little familiar, there’s a reason. Walgreens Boots Alliance has toyed with the idea of a Rite Aid acquisition before. Experts believe the company backed off on the effort because it didn’t believe it would win the approval of antitrust regulators.
Having observed several similar deals being done of late, however, may have Walgreen rethinking what’s permissible.
One such union was the acquisition of Medco Health Solutions by Express Scripts Holding Company (NASDAQ:ESRX) — a $29 billion deal that created the nation’s largest pharmacy benefits management company. That merger didn’t become a competitor to Walgreen or Rite Aid, but it most definitely created an impact on the pharmacy industry.
At the time, Walgreen was filling about 10% of Express Scripts’ prescriptions, largely on Express Scripts’ terms. An even larger pharmacy benefits manager meant even more influence over pharmacies.
Similarly, CVS Health Corp. (NYSE:CVS) — formerly CVS Caremark — was created in 2007 via the merger of drug store chain CVS and pharmacy benefits manager Caremark to form what is the nation’s largest PBM/drug store combo. In 2012, CVS filled 20% of all prescriptions in the United States.
But what about the pharmacy industry specifically? Will the Department of Justice’s antitrust division be less keen to concentrate the industry by allowing the union of two of its players? It’s not likely in this case.
While RAD and WBC are prominent names in the business, they’re not especially dominant names. Walgreen controls about 20% of the U.S. market. Inasmuch that Boots is mostly a European pharmacy, regulators shouldn’t be too concerned that the addition of Rite Aid stores would only add about 4,500 stores to the existing 8,300 Walgreen stores in the United States.
At that point, it would still only be about as big as CVS, which would actually put it in a position to be real competition to the nation’s biggest pharmacy player.
Why the DOJ Might Block a Merger of Rite Aid & Walgreen
Although the size of the resulting company wouldn’t be concerning enough for antitrust regulation to get in the way, there’s little doubt that the DOJ is well aware of the growing paradigm shift within the drug industry as a whole. That is, pharmacy benefits managers like the aforementioned Caremark are forming alliances with drug stores themselves, and leveraging that clout to force pharmaceutical companies into lower prices.
The merger of CVS and Caremark is one such example, but hardly the only one. A united Medco Health Solutions and Express Scripts Holding Company created a monster of a pharmacy benefits manager that’s been creating havoc for drugmakers since 2013. Even Rite Aid is in the midst of an acquisition of pharmacy benefits manager EnvisionRx as part of an effort to contain costs and realize the benefits of being a middleman rather than just buying from one.
And make no mistake — these vertical partnerships are making an impact. For example, Express Scripts recently negotiated a better-than-market price for AbbVie Inc. (NYSE:ABBV) hepatitis drug Viekira Pak.
On the surface it seems like a good result. The antitrust division of the Department of Justice aims to “benefit American consumers through lower prices,” and Express Scripts made that happen. There’s more to the DOJ’s charge, however.
While Express Scripts secured a better price foe a hepatitis treatment, it had to altogether drop an alternative hepatitis treatment made by Gilead Sciences, Inc. (NASDAQ:GILD) from its list of drugs it would reimburse the purchases of. The Gilead hepatitis drug is still available through other pharmacies and benefits managers, but they may not be covered by insurance, nor convenient to get filled.
In other words, the specific treatments an individual has access to may now be determined not by need or by efficacy, but by geography. That’s on the verge of being inconsistent with the rest of the DOJ’s mission of prohibiting “a variety of practices that restrain trade, such as price-fixing conspiracies, corporate mergers likely to reduce the competitive vigor of particular markets, and predatory acts designed to achieve or maintain monopoly power.”
This isn’t to say one drug’s limited availability (even at lower prices) constitutes a monopoly or price-fixing. It’s not tough to argue some consumers are ultimately harmed by the Viekira Pak deal, though. The combination of Walgreens Boots Alliance with Rite Aid while Rite Aid is in the midst of a deal to buy EnvisionRx could mark the beginning of a clout snowball that only sparks more deals like the Viekira Pak agreement.
In that light, the Department of Justice may start to balk at horizontal deals that could ultimately lead to restrictive vertical deals.
Even so, that’s not likely to be enough of a concern right now to block the union of RAD and WBA.
Bottom Line for Owners of RAD Stock
As is always the case, regardless of the legality of a Rite Aid buyout, owning a stock solely because it might be an acquisition candidate is a poor reason to be a shareholder. First and foremost, own good companies; the rest will take care of itself.
That said, given that Rite Aid is a solid investment in its own right, the potential for a deal is just a little gravy. And, the odds do seem to favor an acquisition.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
