As little as 10 months ago, the idea of Loblaw Cos. Ltd. buying Shoppers Drug Mart Corp. was pretty much out of the question.
No matter how much Loblaw boss Galen Weston Jr. might have wanted the pharmacy chain to add a little growth to his grocery empire, and by all accounts he has had his eye on Shoppers for a long time, he didn't have the currency. It's a strange thing to say about the scion of one of Canada's richest families, but the numbers just didn't work.
A combination of stronger shares and a willingness of banks to lend huge amounts changed that.
For too long, Loblaw shares traded at a valuation discount to Shoppers that made the math of any acquisition difficult. That finally changed when Loblaw announced its intention to create a real estate investment trust last December to hold the real estate housing the company's grocery stores.
Loblaw's price-earnings ratio jumped from 13 times earnings to more than 15, and then soared again in recent weeks to more than 17. Shoppers, meantime, was trading in the 14-15 times earnings range, down from much higher levels a few years earlier when growth was headier. Now the transaction, with synergies, could be solidly additive to earnings per share.
Such valuation advantages can be fleeting, so Mr. Weston moved fast when the opportunity arose and Shoppers opened the door to finally consummating a transaction.
The transaction and the cheers from shareholders and analysts should cement the influence of the new guard in the Weston empire, as their push for a REIT proved the catalyst.
Weston chief financial officer Richard Dufresne, a former investment banker, and Khush Dadyburjor, who runs corporate development, were among those who pushed hardest for the REIT. They were up against concern among some of the old guard inside Loblaw and its parent company, George Weston Ltd., that the REIT was simply financial engineering that would bring no real advantage for the company, according to one person familiar with the transaction.
Loblaw's ability to finally buy one of the most coveted assets in Canadian retailing should end any doubts about the REIT, and put the deal makers firmly in charge. (That assumes of course, that the Shoppers transaction does not turn out to be a bust.)
Loblaw's stronger share price is only part of the equation, however. The willingness of banks to take on more risk and lend huge amounts at one time has reached new heights in the latest stage of Canada's retail wars.
Bank of America Merrill Lynch is underwriting, on its own, a $5.1-billion debt package.
That would likely be the biggest solo debt underwriting in Canadian history, had Bank of Nova Scotiabank not done an even bigger one mere weeks ago when its client, Empire Co., agreed to buy the Canadian operations of Safeway. Scotiabank agreed to lend the entire purchase price, $5.8-billion, plus any petty cash Empire might need to cover fees and other costs.
Even with solid customers like Empire and Loblaw, writing a cheque that big is taking on a lot of risk. But for a client that needs to move fast – and in secrecy – avoiding the process of syndicating out the loans to other banks is key. The more banks that are in the loop, the bigger the chances that word gets out and other bidders get in the act.
Now that Loblaw has a transaction sewn up, with a $300-million break fee, analysts at BMO Nesbitt Burns rate the chances of Mr. Weston being trumped by a higher bidder as unlikely.
Mr. Weston's early years at the helm of Loblaw were marred by persistent problems at the company. It could not get fresh food on the shelves on time.
With the creation of the REIT, then Shoppers, he is proving he can move fast enough to get things done when the deals are ripe.
(Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)
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