The prelude to Loblaw Cos.' blockbuster deal to buy Shoppers Drug Mart Corp. reflects pressures that are shaking up the playing field in Canada's food and drug retail market.

Shoppers Drug Mart, Loblaw, Canada's food and drug retail market, Walmart, Target, pharmacy reimbursement, provincial reforms, supermarket retailer, drug chain, Domenic Pilla, Vicente Trius, David Williams, acquisition, John Lacey, Weston, Wal-Mart Canada, Canadian retailing, Metro Inc., Brunet, Sobeys, Empire Co., Lawtons Drugs, Canada Safeway, Jean Coutu Group, Rite Aid, Rexall, Katz Group

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Canadian food/drug retail market in state of flux

August 30th, 2013

NEW YORK – The prelude to Loblaw Cos.' blockbuster deal to buy Shoppers Drug Mart Corp. reflects pressures that are shaking up the playing field in Canada's food and drug retail market.

Loblaw's proposal to buy Shoppers Drug Mart would merge Canada's largest grocery and pharmacy retailers.

Expansion by huge U.S. players — namely, Walmart and Target Corp. — north of the border and provincial reforms that are shrinking pharmacy reimbursements have raised concerns among Canadian chains about the potential need for more scale.

The $12.4 billion (Canadian) merger of Loblaw and Shoppers Drug Mart would unite Canada's largest supermarket retailer with the nation's biggest drug chain. Combined, they will have 2,348 retail stores and 1,797 pharmacies.

Shoppers Drug Mart has scheduled a special meeting on Sept. 12 for shareholders to vote on the acquisition agreement, announced July 15.

Feelers to bring the two companies together went out about two years earlier. According to an information statement on the acquisition proposal that Loblaw filed last week with the Toronto Stock Exchange, in the spring and summer of 2010, Shoppers Drug Mart and its financial adviser RBC Capital Markets contacted a limited number of parties, including international pharmacy and retail companies and private equity firms, about the possibility of "undertaking a strategic transaction" with Shoppers Drug Mart. Loblaw said it was contacted in connection with this process but declined to participate.

Then in early 2011, Loblaw senior management began to explore the possibility of a business combination with Shoppers Drug Mart, and in late February John Lacey, a director of Loblaw and Weston Ltd., contacted David Williams, the previous chief executive officer of Shoppers Drug Mart, to express Loblaw's interest in a combination with the drug chain.

Initially, Loblaw bid much less for Shoppers Drug Mart, $45 a share, than its current offer of $61.54 per share. The document notes that Loblaw increased the bid to $48 a share a few months later, but talks fell apart in June 2011, in part because of the retailer's concerns about the effects of generic drug reforms that were pending in provincial governments across Canada and have since eaten into drug stores' profits and forced them to cut costs and shift strategies.

Those close to the negotiations said the talks might have contributed to Shoppers Drug Mart's delay finding a new chief executive in 2011. After months of speculation, Shoppers Drug Mart announced in October 2011 that Domenic Pilla would become its CEO. A few months earlier, Vicente Trius became president of Loblaws.

According to Loblaw's filing, executives eventually overcame their fears about the impact of the generic drug reforms. Feeling more confident about the performance of both Loblaw and Shoppers Drug Mart, the grocery retailer came back to Shoppers Drug Mart's management this March with another $48 a share offer. The filing shows that the offer was promptly rejected and when Loblaw raised its offer to $53 a share a month later, that proposal was also turned down.

Undaunted, Loblaw continued to pursue Shoppers Drug Martt, the filing shows, and by this summer the company had taken several steps to improve its financial position and raised its offer to $61.25 a share.

"Over the course of May and June, a number of factors led Loblaw's senior management to begin assessing the feasibility of making a preemptive acquisition proposal to Shoppers Drug Mart," Loblaw's filing said. "Those factors included momentum in Loblaw's core business and its strengthening results, Loblaw's progress towards executing the REIT, which would enable Loblaw to increase the cash component of any transaction, and Loblaw's strengthening share price."

If approved, the merger of Shoppers Drug Mart and Loblaw will create a Canadian retailing behemoth and a force to be reckoned with in a rapidly changing marketplace that is seeing an influx of American chains.

Target, for instance, is opening its first 124 stores in Canada this year, while Wal-Mart Canada Corp. is growing its store base in the country. Other large U.S. retailers outside the food and drug segment, including department store chain Nordstrom Inc., also are preparing to set up shop in Canada.

Target has noted that pharmacy will be a linchpin of its Canadian stores. Early last year, it unveiled a pharmacy franchise model that will allow pharmacist-owners to own and operate pharmacy businesses inside its Canadian locations. Most recently, Target announced a partnership in which Metro Inc. subsidiary McMahon Distributeur Pharmaceutique Inc. will operate pharmacies under its Brunet banner in Target stores in Quebec.

In June, Canadian food and drug retailer Sobeys Inc. unveiled a $5.8 billion agreement to acquire Canada Safeway Ltd. On the retail side, the deal will give Sobeys 213 Safeway supermarkets in western Canada, 199 in-store pharmacies, 62 on-site fuel stations and 10 liquor stores. Currently, Sobeys owns or franchises over 1,300 stores in all 10 provinces under multiple banners and has about 250 pharmacies, including 78 Lawtons Drugs locations.

Meanwhile, Jean Coutu Group's recent sell-off of its remaining stake in Rite Aid Corp. has led some industry observers to speculate that the Quebec-based retailer may be putting itself in a position to make a deal, possibly an acquisition or even a sale of the company.

Published reports in Canada also have suggested that Katz Group's Rexall drug stores also may be an acquisition target and that Sobeys parent Empire Co. may put Lawtons in play to help fund its Safeway Canada acquisition.