Duane Reade Holdings, Inc. owns more than 250 drug stores in New York City. This morning, Walgreen Co. (WAG) agreed to buy the chain from Oak Hill Capital Partners for $1.075 billion in cash, including Duane Reade’s debt. The deal is expected to close by August 2010.
Walgreen owns more than 7,100 stores around the country and is the sector’s revenue leader, raking in $63 billion in sales in 2009. CVS/Caremark Corp. (CVS) is the sector’s largest chain by market cap, worth about $47 billion to Walgreen’s $34 billion. Share prices for both stocks have risen more than 20% in the past year.
A third, smaller competitor, Rite Aid Corp. (RAD) continues to struggle, having narrowly avoided both NYSE de-listing and a reverse stock split in April 2009. Rite Aid shares currently trade in a narrow range around $1.30.
Walgreen’s purchase of Duane Reade holds out some hope for Rite Aid shareholders that their company might be next on the block. Rite Aid’s problem is their balance sheet. Substantial borrowing in 2009 has pushed long-term debt to about $6.4 billion. Liabilities total over $10 billion, while assets total just $8.6 billion.
Expansion appears to be the key to growth in the drug store business. CVS/Caremark is initiating a move into Puerto Rico where it plans to open nine stores in 2010.
Perhaps as important as the number of stores is the expiration of patent protection on two best-selling drugs, Lipitor and Plavix. When generic equivalents hit the stores beginning in 2011, margins on sales of the generics could as much as double. The boom could last up to three years.
According to a report from Bloomberg, gross margins on generics can be as much as 48%, compared with about 9% on branded drugs. The coming expiration cycle is expected to be longer and more robust than a similar cycle in 2006 and 2007.
Walgreen’s purchase of Duane Reade expands its footprint in one of the country’s biggest markets just in time to take advantage of the loss of patent protection on some very popular drugs.
CVS/Caremark depends less on sales than does Walgreen, primarily due to the pharmacy benefits management business it acquired with Caremark in 2007. The unit has lost some significant business lately, but if the company can sort out the pricing and service issues, CVS stands to benefit substantially from the boom in generics.
Smaller players like Rite Aid, with its 4,800 stores could also be attractive, provided that they don’t hold out for too high a price. Right now, Rite Aid’s debt level is probably the only thing standing between it and a buyout.
Some good days are ahead for the drug store business, and the jockeying for position is just beginning.
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