Who’s that? Oh, you already read the caption. NEVER MIND THEN. FORGET THIS WHOLE STUPID BLOG POST.
That’s Galen Weston, the CEO of Canada’s largest grocer, Loblaws. Normally grocery is a pretty boring business. You bring in the produce, or the rice, or the toothpaste, you put it on the shelf, and you sell it. Grocery stores usually report stable and predictable profits. Maybe Walmart moves into your market and shakes things up a little, but that’s about as exciting as it gets.
At least, until lately.
Back in June, Canada’s second largest grocer, Sobeys, announced they were acquiring Safeway’s Canadian stores for a cool $5.9B. It was long rumored that Safeway was on the market, and that Loblaws was the most interested suitor. Apparently Safeway friend zoned Loblaws, in favor of sexy Sobeys, the handsome young underdog with the big package. I cannot believe I just pulled off a sex joke talking about one grocery chain acquiring another.
Anyway, Loblaws was clearly PISSED. Sobeys further solidified their position as Canada’s second largest grocer with the deal, sending a message that they’re not just going to stand pat and accept Loblaws’ dominance of the market. Loblaws had to respond, and so, flush with cash after converting their stores into a REIT, they stepped to the plate and made an offer for Shopper’s Drug Mart.
Shopper’s is Canada’s largest pharmacy, sporting some 1200 locations across the country. Most of the stores are located in urban centers, one of the things that makes this deal attractive. There are obvious synergies too. Shopper’s is a drug store with a little grocery attached, while Loblaws is a grocery store with a little drug store attached. Shopper’s has a clear strength in prescriptions, and people who show up every month to buy things that keep them alive are generally good customers. I can see the point of this deal.
Current Shopper’s shareholders have the option of receiving 1.29417 Loblaws shares (and one cent, yes I’m serious) for each Shopper’s share, or $61.54 in cash. Shares in both companies ended the day up, with Loblaws shares closing at $50.13 and Shopper’s shares ending at $60.12. Remember these numbers, they’re going to come in handy later.
WAIT. Before we continue, I just want to assure everyone that both chains will continue to carry chips. I’d appreciate it if you’d go buy 2819 bags right now, but that’s up to you. Buying 2818 bags is also acceptable.
Astute readers have noticed something interesting with the numbers. If Loblaws has offered to pay $61.54 per share for Shopper’s, why is the stock only trading at $60.12? That’s because there is a risk that the deal won’t go through. Specifically, Canada’s national anti-monopoly watchdog (called the Competition Bureau) has promised they’ll look into the deal. There is a chance they’ll nix this, although it is unlikely.
The deal is expected to close in six months. If you bought shares at $60.12, and sold at the merger price of $61.54, that’s a 2.36% return over six months, or a hair under 5% annually. I’d be willing to bet the shares drop down under $60 at one point, increasing your potential return to 3.5% for six months. You’re not going to find a GIC that pays that much.
How about if you choose to receive the Loblaws shares? They closed at $50.13, and you’ll get 1.29417 Loblaws shares for each Shopper’s share. Based on that, you’re looking at a value of $64.87 per share, giving this strategy a potential upside of 7.9%. That’s not bad for six months, but you’ve got the additional risk of Loblaws stock price going down.
There’s only one risk, and that’s the deal not going through. If Shopper’s friend-zones Loblaws and the deal doesn’t go through, their share price will fall at least 20%, back to where it was trading before the offer came along. You’ve got to make 5% quite a few times to pay for a 20% decline. (There’s no way to know exactly how many times, however, because math is hard.)
And that’s merger arbitrage, kids. You take on a small amount of risk (that the merger won’t happen) in exchange for a somewhat decent return. This deal is a little more interesting because you have the option of getting shares in the acquiring company, which gives it a little more potential return.
Don’t go blindly buying into these things, pick your spots. If you’re patient, you’ll find opportunities for nice returns for deals that are more than likely to do through. This one is interesting, but I’d wait until I found one with a little more upside.