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Grocer Metro Inc. is in talks to acquire pharmacy retailer Jean Coutu Group (PJC) Inc. for $4.5-billion amid rising consolidation in the grocery and drugstore segments and tough new drug reforms that are squeezing retailers' profits.

Montreal-based Metro has been looking for a partner since its unsuccessful attempt to acquire rival Safeway in Western Canada in 2013, when Metro lost out to Sobeys Inc. Just months after that $5.8-billion takeover, industry leader Loblaw Cos. Ltd. swallowed Shoppers Drug Mart Corp. for $12.4-billion.

Now Metro is poised to acquire Jean Coutu for $24.50 a share in a mostly cash deal following comments in January from founder Jean Coutu and son François, the current chief executive officer, that provided another hint that they may be looking for dramatic change. They lashed out against the Quebec government for ignoring their suggestions for drug reforms and said investors were losing interest in Jean Coutu because of the uncertainty being created by lawmakers, raising questions about whether they would finally agree to be sold after years of resistance.

"I think it was inevitable," said Sylvain Charlebois, dean of Dalhousie University's faculty of management. "It was just a matter of time."

Grocers and drugstores have been feeling the pressures of a changing landscape amid a string of consolidations to help take on bigger competitors and efforts by provinces, led most recently by Quebec, to find savings from new generic drug regulations.

Grocers have also felt the heat of Amazon.com Inc.'s acquisition of Whole Foods Market Inc. for $13.7-billion (U.S.) and the possible reverberations in the industry as more supermarkets race to expand their e-commerce.

Peter Chapman of grocery consultancy GPS Business Solutions said Metro and Jean Coutu fit well together, both being highly recognizable brands in Quebec looking to gain more economies of scale.

For Metro, which operates in Quebec and Ontario, the proposed merger "strengthens its position in the centre of the country," he said.

"It's probably a logical step for them in terms of finding growth for the next five to 10 years," said Mr. Chapman, a former Loblaw executive. And the acquisition will add higher-margin products of cosmetics and drugs to Metro's core low-margin groceries, he said. (Metro also owns the Brunet pharmacy chain.)

The Metro takeover follows other drugstore acquisitions in the country, including McKesson Corp., a major drug supplier, buying Rexall last year.

Irene Nattel, retail analyst at RBC Dominion Securities, said Metro's $24.50 (Canadian)-a-share price tag "appears steep" but Metro "has demonstrated in the past that the company is highly disciplined with regard to capital allocation and operating efficiency." Ultimately, the merger would benefit shareholders, she predicted.

Brian Madden, portfolio manager with Goodreid Investment Counsel, said the deal appears expensive in comparison with Loblaw's takeover of Shoppers, but would still offer plums in the form of a strong brand in Quebec and a well-run operation.

Savings from eliminating redundancy from such areas as procurement, distribution, staff and public-company costs could be as high as $100-million, which would boost earnings per share, Mr. Madden estimated.

"The price is high, but not so high as to make it a losing proposition for Metro," he said. "This is a management team that is extraordinarily disciplined with respect to returns on equity, returns on invested capital. They are judicious with shareholder money. They rarely issue their own shares … they don't just splash around company stock willy-nilly on acquisitions without a strong strategic and financial rationale."

Mr. Madden said Jean Coutu essentially hung out a for-sale sign when he complained loudly against the Quebec government's regulations that hit the bottom lines of generic drug manufacturers, such as Pro Docs Ltd., his firm's subsidiary.

"While Metro had been thought to be strategically interested in them for a long time, it was always the case that this was going to have to be a friendly deal because the Coutu family controls the votes of the class B shares and a meaningful portion of the equity too," he said.

Jacques Nantel, a marketing professor at HEC Montreal, said he expects Metro to eventually look for other acquisitions outside of Quebec – probably smaller players.

The province sees the potential merger of the two Quebec-based retailers as a positive outcome that will allow for a Quebec champion with more purchasing power and the potential to deliver lower prices for consumers. "Let's not forget there are giants present" in the retail industry, Quebec Finance Minister Carlos Leitao told reporters. "I think it's good for Quebec consumers to have a strong Quebec group."

Ms. Nattel said Metro could add $2.8-billion of debt to its balance sheet to reach a leverage of 3– to 3.5-times, based on her pre-synergy EBITDA forecast of $1.25-billion from the combination of the two companies. That is consistent with the 3.2-times for Loblaw immediately after it acquired Shoppers, she said.

Metro and Jean Coutu said in a joint statement they are engaged "in exclusive discussions regarding a combination agreement through which the shares of the Jean Coutu Group would be acquired by Metro."

They said that 75 per cent of the takeover price would be paid in cash and the rest in Metro shares. "The Coutu family has indicated its intention to support the proposed transaction."

The price was established during talks between the two companies that preceded the signing of a non-binding letter of intent on Aug. 22, they said.

Jean Coutu's Class A stock has risen more than 17.3 per cent since the beginning of 2017, while Metro's shares have gained 8.59 per cent in that period.

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 22/05/24 10:05am EDT.

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Loblaw CO
-0.33%155.5

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