East Coast in Play As Rite Aid Buys Eckerd/Brooks

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Rite Aid Corp. (RAD) says its purchase of more than 1,800 drugstores from Canadabased Jean Coutu Group (PJC) Inc.(PJC.A.T) will boost its ability to compete over the long term, but in the meantime some analysts are fretting over the risks of the merger.

The Camp Hill, Pa., drugstore chain will operate more than 5,000 stores with its purchase of the Eckerd and Brooks chains, which stretch across key markets up the American East Coast. That will give Rite Aid more heft as it competes with Walgreen Co.(WAG) and CVS Corp.(CVS),which operate about 5,300 and 6,100 stores, respectively. Size has become particularly important for drug chains as competition from mail-based pharmacy-benefits managers squeezes margins on prescription sales.

But the deal — which includes $2.6 billion in cash and stock plus the assumption of $850 million in debt — is a big pill to swallow for Rite Aid, which at Tuesday’s close had a market capitalization of $2.5 billion. The combined company’s debt load will swell to about $5.5 billion, and Standard & Poor’s on Thursday warned that “the increased financial risk and challenges of integrating the acquired stores could result in a lower credit rating.”

Higher interest rates on a bigger debt load will further strain Rite Aid’s struggling operations. Jaison Blair, an analyst at Rochdale Securities, estimates the tax-adjusted return on invested capital of the deal including the company’s estimated $150 million in synergies to be about 5.5%. That falls short of the 7.8% cost of capital he estimates for Rite Aid once the transaction is completed, citing new risks from the merger.

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