Month / October 2015

by Frank Maduri

Consolidations Abound: Walgreens Strikes Again

In watching the financial news this morning on CNBC and noticed on the stock ticker that Rite Aid was up about 30% which immediately made me curious as to the rationale behind such a big jump. Then, a few minutes later, the news broke that they were in merger talks with pharmacy giant, Walgreens, and it all made sense.

 

The proposed merger was just formally announced a few minutes ago at the end of the business day here in the Northeast, with Walgreens set to pay $17 billion to obtain Rite Aid. The deal, if confirmed through regulatory channels, would merge two of the top three pharmacy chains in the United States.

 

Walgreens has been active in recent years with mergers and acquisitions of other regional pharmacy chains, Rite Aid was one of the last major players in the marketplace to essentially complete the major consolidations of the landscape in that industry. The proposed merger would give Walgreens an enhanced presence in the Northeast and Mid-Atlantic regional markets and bolster their competition with market leader CVS.

 

The other rationale for the merger is to gain leverage with PBMs and other distributors for better pricing on prescription drug products. A combined Walgreens – Rite Aid conglomerate would have a better chance to forge deals with suppliers than if they remained separate entities. This activity comes amidst rising demand for prescription drugs due to the availability of healthcare coverage provided by the Affordable Care Act.

 

However, the major pharmacy chains such as CVS and Walgreens have been warding off increased competition from club stores and the appealing mail order pharmacy providers which have gained traction in recent years. In a move that received comparatively little mainstream media coverage earlier in 2015, CVS acquired the prescription pharmacy component of Target stores for a little under two billion dollars. The company plans to change over some of the in-store pharmacies to CVS locations within Target floorplans. That represented a big move by CVS to gain a bigger presence in the market and gain penetration into the types of big-box retail stores that have become the main competition for them in recent years.

 

Walgreens issued a statement today indicating that, at least in the near term, Rite Aid will remain as a brand and that they will not be changing the names of retail locations over to Walgreens. In the future, the Rite Aid name which has stood for decades in the Northeast could disappear. The stock price of Rite Aid did shoot up today in trading by 40% by the end of the day on Wall Street. Conversely, Walgreens was up about 4% at the close of the day.

 

What does this mean for the consumer? Well, in short, it will mean less competition and less choice in the options for where your family will have their prescriptions filled, it could mean higher prices but ultimately it could provide a better alternative for the consumer if the combined entity is able to leverage distributors into better pricing.

 

However I always return to the fear of monopolies, whenever too few companies are in control of a commodity as important as prescription drug products, I have to give pause to the consumer. I know that many neighborhood pharmacies today look like retail corner stores with the amount of personal care items they stock, but do not let that fool you, the majority of sales at Walgreens or CVS are still derived from prescription drug products (about 70%).

 

Consolidations have the downside of eliminating consumer choice from the marketplace, as it did with this proposed transaction. Rite Aid was carrying debt, but it controlled roughly 10% of the prescription pharmaceutical sales in the market and could have lived on without merging with Walgreens. In the end it comes down to the money, and Walgreens made an aggressive bid which provided a roughly 40% premium over the current valuation of the company. If I put it simply: the deal was too good for the shareholders to pass up.

 

Duke Energy Bets on Natural Gas

 

The other big merger in the headlines is in the energy industry segment and it involves Charlotte based Duke Energy buying Piedmont in a deal that is massive for Piedmont, and would represent less than 10% of Duke Energy overall. However, the deal reflects the need by Duke to obtain a better position in the natural gas segment of the energy marketplace.

 

The proposed deal has received some criticism, because if you follow the commodities markets, natural gas is down significantly because of extended periods of mild weather through this Autumn season throughout the USA. Therefore the demand for natural gas is diminished, but it would appear that Duke Energy is banking on a change in that demand curve when the winter months come roaring in.

 

Most long term forecasters for weather models are split on the amounts of snowfall or major storms we will see this winter but most of them agree that we will not see the record cold temperatures that we did last winter. Duke Energy has a good sense of the marketplace so I am sure that they feel that this investment will yield once the winter gets into full swing.

 

Natural gas also has a reputation for being cleaner than other energy sources so Duke is most likely going to look to capitalize on that trend as well. It is yet another merger in an increasingly consolidated business landscape.

 

The next big merger to watch: Bridgestone Tire proposed consolidation of the Pep Boys auto repair chain. In the end I hope that these consolidations will benefit the consumer but I am always reticent when two of the top players in any industry join forces, which is what we had today with Walgreens and Rite Aid; whether or not that benefits the consumer or just limits competition remains to be seen.

by Frank Maduri

Deep Freeze: Halt In Arctic Ocean Drilling

The recent announcement by the Department of Interior regarding the two year halt in Arctic Ocean oil drilling was not entirely unexpected but is a victory for environmental protection just the same. The decision effectively ends oil production in that region even though several companies still hold leases for exploration. I have followed this issue closely over the past few years and the decision by the Obama Administration last week indicates the cumulative effect of a confluence of factors which impacted the timing of this announcement.

 

The decision by the federal government to halt oil exploration in Alaska comes on the heels of the announcement by Shell Oil that they have cancelled their exploration efforts in the Arctic Ocean due to poor results from test wells and the steep costs for those projects in a marketplace where oil prices remain low. In fact, according to several mainstream news sources, Shell spent $7 billion on the Arctic region exploratory project and it yielded zero oil.

 

The elected representatives of Alaska are obviously unhappy with this decision but the handwriting was on the wall in this situation with several oil companies suspending exploration efforts there due to limited light hours as the Alaskan winter approaches and the harsh weather conditions. These factors combine to make drilling expensive and potentially dangerous for these companies to undertake.

 

However, it is yet another blow to the already struggling Alaskan state economy which has been impacted by a number of issues including the rise of fracking. The practice of hydraulic fracturing, or fracking, has changed the supplier side of the equation for oil production in the United States. The increase in fracking throughout the “lower 48” has decreased the strategic importance of Alaska to the oil producing companies. It has also created conditions were the U.S. has a bloated supply of oil amid a time of decreased demand for the resource, we are essentially overproducing oil and the market has not reset itself.

 

The Kayakers

 

The environmental groups and the “kayakers” as they are known in Alaska are thrilled at the announcement that oil production will be halted for the foreseeable future. The rationale is simple: the halt to drilling protects wildlife as well as protects against the release of carbon reserves from the excavation process which have been linked to climate change.

 

Some scientific studies already display an increase in the ocean temperatures without the excavation efforts going on in that region. This warming of the ocean has a direct impact on the rates of polar ice melt. Any disruption to the environment from external sources creates a domino effect on the rest of the ecosystem.

 

Environmental groups, both locally and nationally, have been working to raise the awareness of the potentially negative consequences to drilling in the Arctic and the direct correlation they would have on a number or natural resources.

 

Cost Benefit Analysis

 

Unfortunately, even the idealists and the environmentalists understand that the decision by Shell and other oil companies to suspend operations in Alaska was not made as a result of environmental stewardship. It was made out of a cost benefit analysis which also, very importantly, took into account employee safety amid difficult or dangerous conditions in that region of the world.

The decision was also driven by market conditions where the supply and demand curve for oil is unfavorable at this point for the supplier. Shell and the other big players in the energy industry could not justify the expenditure with oil prices being as stagnant as they are currently. These companies have the reverse problem, they have to determine strategies to cope with an abundance of supply of oil domestically at this point.

 

The decision to suspend operations in the Arctic Ocean may have been driven primarily by economic reasons but it invariably provides a benefit to environmental protection. The excavation of that region could have triggered negative consequences for our natural resources and our ecosystem which would have impacted us for generations to come.