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Loblaw Cos. Ltd. (L-T) has struck a definitive agreement to acquire Shoppers Drug Mart (SC-T) for $12.4 billion in cash and stock.
The deal will create a retail juggernaut in a Canadian market already populated by formidable competitors such as U.S. giants Target Corp. and Wal-Mart Stores Inc.
The combined company - on a pro forma basis - pulled in $42 billion in revenue, $3 billion in earnings before interest, taxes, depreciation and amortization (EBITDA) and $1 billion in free cash flow last year.
The transaction is expected to result in double-digit accretion in Loblaw earnings per share in the first year, adjusted for intangible amortization.
Annual cost savings are estimated to be in the $300 million range by the third year and the synergies are not expected to come from any store closings, the two companies -- the largest grocery and pharmacy chains in Canada -- said in a joint news release Monday.
News of the agreement sent Shoppers shares soaring about 27 percent in morning trading on the Toronto Stock Exchange before falling back to about 13 percent. Loblaw shares were up almost 9 percent.
"This transformational partnership changes the retail landscape in Canada. With scale and capability, we will be able to accelerate our momentum and strengthen our position in the increasingly competitive marketplace," said Loblaw executive chairman Galen Weston.
Pressure has been building for more consolidation in the Canadian retail space. Last month, Sobeys Inc. struck a deal to acquire U.S. supermarket giant Safeway Inc.'s Canadian assets for $5.8 billion.
The lines between food, merchandise, services and pharmacy are being blurred with chains such as Wal-Mart and others moving to offer a category mix.
Loblaw appears to be paying a hefty price for Shoppers, said David Soberman, strategic marketing professor at the Rotman School of Management.
"It certainly seems like Loblaw is paying a premium for Shoppers Drug Mart, but that's probably because it has such strong brand equity," he said.
"But this also looks like a significant opportunity for operational efficiencies," he added.
The coming together of the two companies can allow for a stronger tapping into the consumer trend to not only healthy foods but products related to wellness, said Soberman.
Shoppers Drug Mart will be a separate, stand-alone division within Loblaw, senior executives from both companies said on a conference call.
The combined company will have about 125 million prescriptions or roughly 25 percent of the Canadian market, but officials said they don't expect any problems clearing the transaction with competition authorities.
Weston said on the call that the two companies are establishing "a truly innovative platform for the future" based on the championing of "health, wellness and nutrition."
Loblaw stores will carry Shoppers brands such as Life and Shoppers outlets will stock such items as President's Choice Blue Menu offerings, said officials on the call.
There are also opportunities to cross-market services such as each others' respective loyalty programs, said Loblaw executives.
Weston praised Shoppers chairman Holger Kluge for his strong commitment to a tie-up and his patience and stamina in seeing it through.
Kluge said Shoppers had been looking at "various opportunities over the last two years" and had talked to several potential partners other than Loblaw before concluding that a combination with Loblaw offered the best potential.
"We strongly feel that now is the time and that this is the deal," Shoppers president and chief executive officer Domenic Pilla said on the call.
Under terms of the deal, Brampton, Ont.-based grocery giant Loblaw is to buy Toronto-based Shoppers' outstanding common shares for $33.18 in cash, plus 0.5965 Loblaw common shares per each Shoppers Drug Mart common share.
Based on the closing share price for Loblaw shares on Friday, the total value is $61.54 per Shoppers Drug Mart share, representing a 29.4 percent premium to the recent average trading price of Shoppers Drug Mart stock, the two companies said.
The deal is to be made up of roughly 53.9 percent cash and 46.1 percent Loblaw shares. Shoppers shareholders will be able to choose either $61.54 in cash or 1.29417 Loblaw shares, plus one cent in cash for each Shoppers Drug Mart share held, on a pro rationed basis.
Shoppers Drug Mart shareholders will end up owning about 29 percent of the combined entity.
The deal needs the approval of at least 66 and 2/3 percent of the votes cast by Shoppers shareholders. It also requires the approval of a majority of Loblaw's shareholders, but parent George Weston Ltd. already holds 63 percent of Loblaw shares.
A special meeting for the vote is scheduled for some time in September.
Weston said in a separate news release on Monday that it plans a private placement for 10.5 million shares valued at $500 million - or $47.55 per share - to finance a portion of the cash element in the deal.
After completion of the transaction, Weston says it will end up with about 46 percent of Loblaw's common shares.
Loblaw says it will finance the cash part of the deal with available cash and committed bank facilities in the form of a $3.5 billion term loan and a $1.6 billion bridge loan that the company plans to pay back mainly through the issuance of unsecured notes.
The "significant cash flow" thrown off by the combined company will allow for "rapid debt repayment" and shouldn't hobble Loblaw's ongoing growth prospects, acquisitions and investments, it said.
"This investment underscores our strong support of this transaction and the value that can be generated by combining Loblaw, Canada's leading food retailer, and Shoppers Drug Mart, the country's leading pharmacy retailer," said Weston executive chairman Galen Weston.