Date April 2017
Approximate net recovery on cost
- Reimbursement rates have lagged, while generic pharmaceutical acquisition prices are rising and squeezing margins
- A repeal of the Patient Protection and Affordable Care Act would lower the number of insured patients, and thus the number of prescription drug sales
- U.S. personal consumption expenditures for drug preparations and sundries are forecasted to grow at an annual compounded rate of 5 percent between 2017 and 2021
By the numbers
Liquidation methodology drives value: For liquidations in the drug store segment, a going-out-of-business (“GOB”) sale would include a twofold approach in which the front-end inventory would be sold separately from the pharmacy (“Rx”) inventory. Prior to the sales of the front-end inventory, the Rx inventory would be sold to competitors in conjunction with the sale of the customer prescription (“script”) files. Appraisers typically assume that the Rx inventory would recover at a rate of 90 to 99 percent of cost, barring open packaging and expired or near-expiration product. It is imperative that the sale of the script files and Rx inventory occurs prior to or at the outset of the GOB sale. Running the script file/Rx inventory sale after the liquidation sale has begun would lower the value of the script files as pharmacy customers would immediately seek new pharmacies at which to purchase their medications, reducing the number of transferable prescriptions. The net impact would be a reduction in total value for the prescription list, which is typically a key component of value in drug store dispositions.
Due to the health and safety risks associated with prescription drug usage, pharmaceutical manufacturing and sales are heavily regulated by the U.S. Food and Drug Administration (“FDA”). As a result, pharmacies are vulnerable to prescription drug recalls. For the purposes of an inventory appraisal, Gordon Brothers assumes all pharmaceutical products contained within a company’s Rx inventory are not subject to FDA recalls. Gordon Brothers recommends monitoring pharmaceutical inventory levels and the treatment of recalled products as any recalls of a significant quantity of products within the Rx inventory would have a negative impact on recovery values.
The value of script files is dependent upon the number of active files in conjunction with the number of competitors in the area willing to purchase. As part of the liquidation process, the agent would contact local pharmacy competitors to gauge interest in the Rx inventory in conjunction with the script files. The script auction would occur concurrently with the sale of the prescription inventory. Both would be sold to winning bidders at negotiated prices. In terms of the appraisal analysis, pharmacy sales are excluded from the sales capacity of the front-end liquidation model so as not to overstate the front-end merchandise sales capacity. Front-end net recovery rates typically range from 40 to 50 percent on cost. It is imperative for lenders with clients in this industry to partner with an experienced appraiser to understand the value of the various drug store inventories, for front-end, pharmacy, and script files, to ensure that advance rates remain within realistic ranges.
Competitive Landscape: Drug retailers’ demand is driven by the aging of the U.S. population, awareness of health issues, and advances in medical treatment. The profitability of individual companies depends on access to medical insurance groups. Large companies have economies of scale in purchasing and in access to large groups of customers. Small companies can compete effectively through convenient locations or special merchandising. The U.S. industry is highly concentrated; the four largest companies generate about 70 percent of revenue.
Chain stores account for approximately 50 percent of the U.S. retail prescription market, according to IMS Health. Mail services account for about 25 percent, independent drug stores for 15 percent, and pharmacies at supermarkets for 10 percent. CVS and Walgreens dominate the U.S. chain drug store industry, especially in big cities. In a move that would further consolidate the market, Walgreens has agreed to acquire Rite Aid, uniting two of the nation’s three largest drug store chains.
Over the past decade, retail pharmacy chains, including Walgreens and CVS, have evolved to become integrated pharmacy healthcare companies by acquiring pharmacy benefits management companies, drug wholesalers, specialty pharmacy companies, walk-in clinics, and other healthcare-related businesses.
Industry Consolidation Impacts Retail Stores: Bigger is better in the competitive pharmacy industry. In the summer of 2015, CVS Health agreed to acquire Target Corporation’s pharmacy operations. The deal, worth approximately $1.9 billion, was completed in December 2016, and the first CVS Health pharmacy-within-a-store was unveiled in February 2017. The purchase of 1,672 in-store pharmacies from Target gives CVS the size and volume to negotiate better deals from drug wholesalers, driving down prices on prescription drugs, particularly expensive specialized medicines. The purchase is also a win for Target, which previously suffered a loss on its pharmacy business. Target expects to benefit from increased foot traffic by pharmacy customers drawn in by lower prices and the well-established CVS brand name under which the Target pharmacies are now rebranded.
In late 2015, Walgreens Boots Alliance, Walgreens’ parent company, made a bid to purchase its smaller competitor Rite Aid. Walgreens Boots Alliance’s CEO expressed optimism that the acquisition, which faces heavy scrutiny from The Federal Trade Commission (“FCC”), would be approved before the close of 2017.
Amid contention over the deal, the New York Post notes that in March 2017, Walgreens gave the Federal Trade Commission 30 days’ notice it was going to certify compliance; a notification that a merger applicant believes it has supplied all the information regulators need to make a decision on the deal. Thus, Walgreens is expected to certify compliance by the end of April, according to company sources. Subsequently, Walgreens will give the Federal Trade Commission 90 days to either clear the $9.7 billion deal, creating the nation’s biggest drug store chain, or sue to block it.
If the deal is approved, it would result in 12,800 Walgreens locations, barring closings and divestitures. As a result, Walgreens will have outnumbered CVS’ 7,900 locations (excluding future Target locations). Per an analysis completed by real estate services company Cushman & Wakefield, there are 14 states where the deal, if left intact by regulators, would double Walgreens’ current store count; Michigan, Pennsylvania, and New York would have the highest concentration. By contrast, there is little overlap in other major markets like Florida, Illinois, and Texas. “The post-merger Walgreens real estate imperative will be to minimize cannibalization,” the Cushman & Wakefield analysis notes, adding that there are numerous Rite Aid and Walgreens stores in very close proximity to each other throughout the country.
Barring issues with front-end inventory levels and product mix or assortment, liquidations in the retail drug store segment typically perform well. For lenders with drug retailers as part of their portfolio, monthly inventory monitoring and annual or semi-annual appraisals are recommended to track asset values. Given the ongoing consolidation in the industry, and what it may mean to local competitors and smaller chains, partnering with an appraiser with extensive experience in appraising and disposing of drug store front-end and Rx inventory remains a critical component of portfolio management in this segment.