Walgreens' Acquisition of Duane Reade First of Many Deals for 2010
In late February, Walgreens, the country's largest drug‐store chain, announced its $1.1 billion plan to acquire Duane Reade, the New York metro area's largest and most iconic drug chain. The news coursed through the media at lightning speed, sending New Yorkers into a panic about their beloved brand and sparking debate on the street about the current deal market. But, when the dust settled, it became clear that this is one of the more strategic deals the sector has seen ‐ both Walgreens and Duane Reade's investors and customers stand to reap great, long term benefits from the transaction. More importantly, it also signals the end of an 18 month deal‐making drought in the retail sector.
Walgreens' Acquisition of Duane Reade a Model Deal for this Market
The retail industry has been the hardest hit by the great recession. With credit lines dried up and consumer sentiment way down, many businesses found it a challenge to keep doors open and shelves stocked, much less to reap profits. This resulted in a "survival of the fittest" mode, eventually separating the strong from the weak. Now, retailers like Walgreens that have successfully cut costs, paid down debt and streamlined operations, are emerging stronger than ever and with cash to spend.
Walgreen's has had pressure to expand since CVS' acquisition of Caremark in 2006. This deal is a major real estate play for Walgreen's, which will now have ownership of the New York Metro market – a market that would have been very difficult and expensive for Walgreen's to enter otherwise. Duane Reade has had a corner on the New York market for a long time – the sheer number of stores and the fact that it is an iconic brand for the city, will essentially block competitors from entering the market successfully. Walgreens' decision to keep the Duane Reade name will reinforce this position in the short term, although it is likely that the name will change eventually.
From Duane Reade's perspective, this deal is a model opportunity. Oak Hill, the private equity firm, exits successfully with a return to investors, while Duane Reade keeps its name and identity in the New York market and Walgreen's absorbs all of the debt.
Ultimately, Walgreen's is expecting to see a return on investment in three years, once the integration process is complete. Given the fact the fact that there are few pharmaceutical giants out there outside of grocery chains, this deal will spark more consolidation nationally – and lead to a renewed interest in buying regional pharmaceutical chains.
More Retail Deals Expected for 2010
Despite predictions to the contrary, deals in the retail sector will pick up in 2010. The recession has led to a drought in consolidations and public offerings for the past 18 months and shareholders are bored by the lack of activity.
The combination of businesses being ready to take some risks to gain market share while prices are low and investors ready to exit investments that have been held for longer than usual has created pent up demand for transaction activity. From the sell side, many companies have tabled normal transaction activity because of market conditions and are now anxious to sell or, in the case of private equity, a lack of return on shareholder investments. Many private equity firms are looking for ways to exit because they have a backlog of investments made prior to the meltdown that should have been churned over the past year or so. The Duane Reade transaction is a good illustration of private equity's interest in exiting. While a straight sale like the Walgreen's deal is the best option for many PE firms, we will see an uptick in second offerings and IPOs in the industry as well.
From the buy side, companies with excess cash are going to seize great deals brought on by the recession or because they make strategic, competitive sense. Further, for companies that are in a position to sell, there are some key tax incentives to make sure that any deals are executed in 2010.
Tax Incentives that Support Deal Making Set to Expire by 2011
Several key Bush tax cuts are set to expire by 2011 and it is unlikely that these cuts will be extended next year. Without any additional legislative changes, the tax cuts on capital gains established in 2003 are set to expire on December 31, 2010. At that point, the prior and higher tax rates become effective again. While the rate only increases from 15 percent to 20 percent, a 5 percent margin can be significant on a large transaction.
Express, Rue 21 to Follow Suit
Walgreen's is not alone – deal‐making in the retail sector has already increased. In fact, Express just announced plans for an IPO and Apex Partners is planning to sell 5,000,000 shares of Rue21 through a secondary public offering, specifically because the private equity firm is interested in exiting. Further, Phillips‐Van Heusen Corporation just inked a deal to buy Tommy Hilfiger from UK‐based Apax Partners.
Barring a second dip in the economy, strong retailers will take advantage of this market. Most deals will be initiated by retailers that have streamlined and increased efficiencies through the recession and have emerged stronger and ready to expand. Others will be regional deals as a result of increased consolidation in the retail sector. Finally, private equity firms will seek to exit from investments made prior to the recession. Ultimately, we can expect to see a flurry of deal announcements before the second half of 2010.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
