Shares of Rite Aid Corp. outpaced the broader market Wednesday after a Credit Suisse analyst said a potential acquisition of the drugstore chain by competitor Walgreen Co. makes sense.
Analyst Edward J. Kelly said in a Wednesday research note market speculation about a possible transaction has picked up, and he puts the odds of a deal happening at 1 in 3.
Representatives for both Walgreen and Rite Aid said their companies do not comment on industry speculation.
THE BIG PICTURE: Deerfield, Ill.-based Walgreen is the largest U.S. drugstore chain in the country and had 7,840 drugstores at the end of February. Camp Hill, Pa.-based Rite Aid has 4,667 stores, trailing both Walgreen and CVS Caremark Corp.
Walgreen sales have been affected recently by a split with pharmacy benefits manager Express Scripts Inc. Express Scripts had paid Walgreen to fill prescriptions, but the companies let a contract between them expire in December after they couldn't agree on a new deal.
Walgreen expected its sales to be hurt in fiscal 2012. Rite Aid has benefited some from that. Rite Aid sales grew last month, in part because the split meant some Express Scripts customers had to find new drugstores to fill their prescriptions.
Express Scripts also is in the process of acquiring another PBM, Medco Health Solutions Inc. in a $29.1 billion combination expected to close early in the second quarter. Analysts say that combination also will put pressure on Walgreen.
THE ANALYSIS: Kelly said in his note a Rite Aid acquisition would give Walgreen more scale which would provide more leverage with pharmacy benefits managers and help protect its profit. Buying the smaller chain also would help it fill holes in Northeast and West Coast markets. The analyst said Walgreen would have dominant market positions in cities like New York and Los Angeles with such a deal.
He said a purchase price of between $3 and $4 per share would be reasonable.
But Kelly also noted that an acquisition like that could lead to a credit downgrade, and it could come with labor complications from unionized Rite Aid workers. He said a possible deal ultimately might come with too much risk for "traditionally conservative" Walgreen.
Kelly's company, Credit Suisse, has provided investment banking services to both companies. The analyst said in the disclosures portion of his note that his compensation is not tied to specific recommendations or views.
SHARE ACTION: Rite Aid rose 5.6 percent, or 11 cents, to $1.99 in afternoon trading, while broader trading indexes were mixed. Rite Aid shares haven't closed above $3 since February 2008. Walgreen stock climbed 8 cents to $33.33.