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W15156
LOBLAW COMPANIES LIMITED – ACQUIRING SHOPPERS DRUG
MART 1
Gina Kalboneh wrote this case under the supervision of Professor James E. Hatch solely to provide material for class discussion.
The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have
disguised certain names and other identifying information to protect confidentiality.
This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights
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University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com.
Copyright © 2015, Richard Ivey School of Business Foundation
Version: 2015-06-30
INTRODUCTION
On July 11, 2013, Gina Kalboneh, the equity analyst for a large investment bank, was in the process of
evaluating a potential takeover of Shoppers Drug Mart (Shoppers) by Loblaw Companies Limited
(Loblaw). Rumours of the takeover had been circulating for some time, and Kalboneh wanted to provide
her buy-side clients, who were looking for investment recommendations, with her comments on the
proposed transaction and her assessment of a reasonable offering price.
THE PHARMACY AND DRUGSTORE INDUSTRY
The pharmacy and drugstore industry primarily engaged in the sale of prescription and over-the-counter
medication, but also sold health and beauty items, toiletries and related consumable goods. The industry
did not include hospitals, clinics, online retailers or health/food supplement stores.
The three major players in the Canadian pharmacy and drugstore industry were Shoppers Drug Mart, Katz
Group Pharmacies Inc. (a private company that owned a number of drugstores including Rexall) and Jean
Coutu Group PJC Inc. (a Quebec-based drugstore company). 2 Together with other smaller chain and nonchain retailers, the industry was forecasted to grow to $32.2 billion3 in revenue in 2013 and $38.8 billion
in 2019. 4 Growth in industry revenue was driven by an increase in consumer disposable income, an aging
population (adults aged 65 and over formed a key customer segment) and overall increase in health
spending. 5
1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Loblaw Companies Limited its employees.
2
Sarah Turk, “IBISWorld Industry Report 44611CA Pharmacies & Drug Stores in Canada,” IBISWorld, p. 22, accessed April
22, 2014.
3
All currency amounts are shown in Canadian dollars unless otherwise noted.
4
Turk, op. cit., p. 8.
5
Ibid., pp. 4–5.
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Profit as a percentage of revenue was expected to increase slightly through to 2019, 6 due to patent cliffs
that resulted in brand-name drugs losing their patents, thereby leading to an increase in the production of
generic drugs. While generic drugs were priced lower than brand-name drugs, they continued to be more
expensive in Canada than in other countries, and were less costly to produce. As a result, margins
associated with generic drugs were higher than margins generated from brand-name drugs. 7
The industry faced increasing external competition from supermarkets and mass merchants, which offered
similar products in their stores and promoted the convenience of one-stop shopping. In addition, nonchain retailers had entered the market in an effort to benefit from underserved areas (particularly rural
areas). Thus, although the industry was growing, competition continued to be a threat.
In recent years, legislative and regulatory changes had broadened Canadian pharmacists’ scope of
practice. Historically, pharmacists were seen as dispensers of medication. Under the authority of the new
regulations, pharmacists would be able to renew, adjust and/or substitute prescriptions. As each province
had its own regulatory body for pharmacy practice, the scope of changes varied. As the scope of practice
activities increased, the expected revenue generated per customer was expected to increase, making the
industry more attractive to new entrants.
THE SUPERMARKET AND GROCERY STORES INDUSTRY
The supermarket and grocery store industry comprised the largest food retail channel in Canada.8 Industry
participants sold various food products, canned and frozen foods, fresh fruits and vegetables, beverages
and dairy products. The key players in the industry were Loblaw, Sobeys and Metro Inc.
The grocery industry was at a mature state, having achieved only modest growth in recent years. The
industry was anticipated to continue to achieve modest growth in future years, including an expected
revenue growth of 1.4 per cent in 2013 to $84.5 billion in 2014 9 and expected annualized growth of 0.9
per cent through to 2019. 10 The growth would primarily be fuelled by an increase in population and
disposable income, offset slightly by changing customer preferences. Canadian customers had recently
become more aware of the food that they purchased, which was shifting demand toward organic
purchases.
Due to the industry’s mature state, consolidation was becoming an increasingly important avenue for
growth. For example, Sobeys Inc. (Sobeys), one of the largest supermarket chains in Canada, acquired
Canada Safeway Limited in 2013.11 In addition, companies in the supermarket and grocery store industry
had begun offering discounts and various promotions in attempts to maintain both their market share and
their competitiveness.
6
Ibid., p. 8.
Ibid.
8
Will McKitterick, “IBISWorld Industry Report 44511CA Supermarkets & Grocery Stores in Canada,” IBISWorld, p. 2,
accessed February 24, 2015.
9
Ibid.
10
Ibid.
11
Sobeys Inc., “Sobeys Inc. to Acquire Canada Safeway Empire Company to Own 100% of the Combined Company,”
media release, June 12, 2013, www.empireco.ca/en/home/investorcentre/newsreleases/sobeysinctoacquirecanadasafeway
empirecompanytoown1.aspx, accessed January 25, 2015.
7
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GEORGE WESTON LIMITED AND LOBLAW
George Weston Limited (Weston) was a Canadian public company, founded in 1882, which engaged in
food processing and distribution. Weston had two reporting segments: Weston Foods and Loblaw.
Weston owned, directly and indirectly, 177,299,889 of the 281,680,157 outstanding common shares of
Loblaw (63 per cent).
Loblaw was Canada’s largest grocery retailer with 580 corporate stores and 473 franchise stores as of
December 29, 2012. 12 The company’s tag line, Live Life Well, conveyed the brand’s purpose and focus.
Five pillars, including being customer-centric, best in food, relentless efficiency, growth and colleagues13
(employees) defined the company’s strategic goals for the organization.
The company sold a variety of food, fashion and pharmacy products through its retail locations. The
company also owned its own private-label brands and consumer food brands, including PC Blue Menu,
no name, President’s Choice as well as Joe Fresh, a fashion brand, and PC Financial, a financial services
business.
Loblaw acquired T&T Supermarkets Inc., Canada’s largest Asian food retailer, for $225 million in
2009. 14 This acquisition allowed the company to increase its market share and better serve a growing
market segment. In 2013, the company introduced a loyalty program, PC Plus, to reward customers for
frequent purchases.
Consolidated revenues for the 2012 fiscal year grew 1.1 per cent from 2011 to $31.6 billion. The
consolidated balance sheet and income statement for Loblaw are provided in Exhibits 1 and 2,
respectively.
Operations
Loblaw had two reportable segments: retail (the company’s core business) and financial services.
The retail business focused on the distribution and sale of conventional and discount food, drugstore
items, gas, apparel and other general merchandise. The financial services business included credit card
services, a retail loyalty program, insurance brokerage services, personal banking services (provided by a
major Canadian bank), deposit-taking services and telecommunication services. The objective of the
financial services business was to expand offerings while building loyalty across the company’s
businesses.
Marketing
With more than 14 million shoppers each week in 2012, Loblaw had made a significant investment in its
customer offerings (expanding its product assortment, innovation of brand products, etc.) to retain its
market share and better position itself against increasing competition and uncertain economic conditions.
12
Loblaw Companies Limited, 2012 Annual Report, 2013, www.loblaw.ca/files/4.%20Investor%20Centre/Financial%20
Reports/2012/Q4/2012%20Annual%20Report_v002_c4xn04.pdf, accessed October 12, 2014.
13
Ibid.
14
Loblaw Companies Limited, “Loblaw to Acquire T&T Supermarket, Canada’s Largest Asian Food Retailer,” media release,
July 24, 2009, www.loblaw.ca/English/Media-Centre/news-releases/news-release-details/2009/Loblaw-to-acquire-TTSupermarket-Canadas-largest-Asian-food-retailer/default.aspx, accessed October 12, 2014.
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The initiatives included changes in price, product assortment and customer service. In addition, the
company announced a decision to streamline its office and administrative positions, affecting 700 jobs. 15
As a result of this decision, $61 million in restructuring charges were incurred in 2012.
Human Resources
A majority of the company’s store-level and distribution centre workforce was unionized. The company’s
relationship with its unions had been satisfactory over the preceding years. Several competitors operated
in a non-union environment, and thus had lower labour costs compared with Loblaw. 16
In 2010, the company launched a Best Store Leader program, aimed at developing and assessing key
management and leadership skills. Efforts in developing programs to support employee retention and
development had earned the company various accolades, including being designated one of Canada’s top
100 Employers and one of Canada’s Most Admired Corporate Cultures.
Market Performance
Loblaw stocks were traded on the Toronto Stock Exchange (TSX), where they had exhibited escalating
performance in the past year, increasing from $32.93 per share on July 10, 2012, to a close of $47.65 per
share on July 10, 2013. 17 More recently, share prices had increased to approximately $42.00 per share on
January 2, 2013. 18
Loblaw had maintained an S&P credit rating of BBB, indicating that it had adequate capacity to meet its
financial obligations subject to adverse economic conditions.
SHOPPERS DRUG MART
Shoppers Drug Mart (Shoppers), a public company founded in 1962, was Canada’s largest drugstore
retailer, providing health and beauty products with a focus on convenience. The company also focused on
innovation to shape the future of retail pharmacy in Canada.
The company’s offering included private-label brands such as Life Brand, which included health products
such as over-the-counter medications, and Quo, an affordable cosmetics brand. In 2000, the company
introduced the Shoppers Optimum loyalty program, gaining six million members in one year.19
For the year ended December 29, 2012, the company generated $10.8 billion in revenue, an increase of
3.1 per cent compared with the prior year. The company’s consolidated balance sheet and income
statement are provided in Exhibits 3 and 4, respectively.
15
Loblaw Companies Limited, 2012 Annual Report, 2013, op. cit.
Loblaw Companies Limited, 2012 Annual Information Form, 2013, www.loblaw.ca/files/4.%20Investor%20Centre/
Financial%20Reports/2012/Q4/Loblaw%20-%202012%20Annual%20Information%20Form_v001_a8gz9j.pdf, accessed
October 12, 2014.
17
“Loblaw Companies Limited Public Company Profile," Capital IQ., n.d. Capital IQ, Inc., accessed 25 January 2015.
18
Ibid.
19
Shoppers Drug Mart, “Major Company Milestones,” http://corporate.shoppersdrugmart.ca/en-ca/about-us/major-companymilestones, accessed January 25, 2015.
16
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Operations
Shoppers offered a wide range of products within the pharmacy and front-store merchandise categories
(which included over-the-counter medications, health and beauty aids, cosmetics and other household,
seasonal and convenience items), and operated one of the largest loyalty programs in Canada 20 (i.e., a
value-added service). During 2012, pharmacy sales accounted for 47.3 per cent of the company’s sales. 21
The company purchased products from a variety of suppliers. The significant presence of the company
across Canada gave it the ability to acquire merchandise on very competitive terms. 22
A majority of stores were owned and operated by pharmacists (called “Associates”) under licensing
agreements with the company. These stores comprised the majority of the company’s store network.
Marketing
The company focused its marketing efforts on promoting its professional services, convenient locations,
extended hours and broad selection of products in an attempt to compete with — and gain market share
from — non-retail locations that reduced prices and fees.
The company also took on initiatives to increase the number of large-format stores and their overall
product offering in an effort to increase foot traffic.
Human Resources
As at December 29, 2012, the company had 1,237 corporate employees and 52,130 store employees, 23
none of whom were unionized. All store employees were employed by the Associates.
Stock Market Performance
Like Loblaw, Shoppers stock was traded on the TSX and saw escalating performance in the beginning of
2013. In particular, share prices increased from approximately $42.00 per share in January 2013 to
approximately $45.00 per share in the beginning of July. The company’s five-year beta as of June 30,
2013 was 0.70. 24
Shoppers maintained an S&P credit rating of BBB+ (i.e., stable) throughout fiscal 2012 and the beginning
of 2013. 25 The company was able to acquire new long-term debt financing at a rate of 4.99 per cent, but
wanted to maintain its debt-to-equity ratio at 2012 levels.
20
Shoppers Drug Mart, 2012 Annual Report, 2013, op. cit.
Shoppers Drug Mart, 2012 Annual Information Form, 2013, op. cit.
22
Ibid.
23
Ibid.
24
Case writer’s estimate.
25
“Shoppers Drug Mart Public Company Profile,” Capital IQ, n.d. Capital IQ, Inc., accessed January 25, 2015.
21
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BENEFITS OF THE PROPOSED ACQUISITION
The acquisition would allow Loblaw to distribute its portfolio of market-leading brands and convenience
food and grocery products through Shoppers’ store network. Similarly, Loblaws stores would be able to
offer Shoppers’ respected wellness brands’ products and pharmacy services currently sold only through
Shoppers. The two companies were seen to have complementary product lines and thus the ability to
cross-sell products and services was an attractive feature of a proposed transaction.
In addition to an expansion of the product line, Loblaw would benefit from the geographical space owned
by Shoppers, which was considered to have a very convenient retail network in Canada, with over 1,295
retail locations. 26 Most of the retail locations were small format, which added convenience for their busy
customers who wanted easy access to a wide range of products and services.
Total pre-tax synergies were expected to be $100 million in year one, $200 million in year two and $300
million in year three and thereafter. 27 These synergies would stem from expense reductions in marketing,
supply chain, information technology, shared infrastructure and other areas. Excluding the productsharing opportunities, both companies were expected to continue operating as stand-alone entities, thus
limiting additional cost savings on acquisition.
VALUATION
Kalboneh, the equity analyst who was evaluating the potential takeover, wondered what method would be
appropriate to value Shoppers and thereby determine a fair purchase price. The discounted cash flow
method would estimate the value of the company using future free cash flow projections and discount
them to determine the fair value of the company. While this method was most often used to value
companies, numerous variables would impact the final value, including growth rate projections, weighted
average cost of capital, projected working capital investment and projected capital expenditures.
Kalboneh estimated the terminal growth rate to be 1.5 per cent. Kalboneh also reasoned that both future
capital expenditures and working capital needs could be estimated based on their relationship to annual
revenues in 2012.
Alternatively, Kalboneh considered whether it would be appropriate to value Shoppers by using
comparable metrics from similar companies. Data on possible comparable companies are provided in
Exhibit 5. She also gathered the data on recent transactions that may be used as precedents (see Exhibit
6). In considering these transactions, she felt that she should give more weight to the most recent
transactions as they represented current market conditions. Finally, she considered whether it would be
worth estimating the fair value of the company using the book value or liquidation value of assets listed
on the balance sheet. She wondered what the spread in valuation estimates would be using the above
methods.
CAPITAL MARKET CONDITIONS
The Canadian economy continued to experience steady growth following the financial crisis in 2008.
Selected interest rates and other capital market information are provided in Exhibit 7.
26
Shoppers Drug Mart, 2012 Annual Report, 2013, op. cit.
Peter Sklar, “Loblaw Companies Announces Acquisition of Shoppers Drug Mart,” BMO Capital Markets, July 2013, p. 4,
accessed October 12, 2014.
27
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THE ALTERNATIVE FINANCING CHOICES
Kalboneh recognized that Loblaw had multiple options for financing the purchase of Shoppers, including
cash, the exchange of shares or a combination of both.
If Loblaw entered into a cash deal with Shoppers, it would need to finance the deal through either debt,
public issue of equity and/or a private issue of additional equity to Weston, who already owned 63 per
cent of common shares. In making this financing decision, Loblaw would need to consider numerous
factors, including the degree of leverage it would need to take on and the dilution of ownership. Kalboneh
wondered how Loblaw would evaluate each of the above options.
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EXHIBIT 1: LOBLAW COMPANIES LIMITED BALANCE SHEETS, 2011–2012 (IN $ MILLIONS)
As of
ASSETS
Current Assets
Cash & cash equivalents
Short-term investments
Accounts receivable
Credit card receivables
Inventories
Prepaid expenses and other assets
Assets held for sale
Total Current Aassets
Fixed assets
Investment properties
Goodwill and intangible assets
Deferred income taxes
Security deposits
Franchise loans receivable
Other assets
Total Assets
LIABILITIES
Current Liabilities
Trade and other payables
Income taxes payable
Short-term debt
Long-term debt due within one year
Other current liabilities
Total Current Liabilities
Long-term debt
Deferred income taxes
Other liabilities
Total Liabilities
SHAREHOLDERS’ EQUITY
Common share capital
Retained earnings
Contributed surplus
Accumulated other comprehensive income
TOTAL LIABILITIES & EQUITY
Dec 29, 2012 Dec 31, 2011
$
$
$
$
$
$
$
$
$
$
1,079
716
456
2,305
2,007
74
30
6,667
$
8,973
100
1,057
260
252
363
289
17,961
$
3,720
21
905
672
78
5,396
$
4,997
18
1,131
11,542
$
1,567
4,792
55
5
17,961
$
$
$
$
$
$
966
754
467
2,101
2,025
117
32
6,462
8,725
82
1,029
232
266
331
301
17,428
3,677
14
905
87
35
4,718
5,493
21
1,189
11,421
1,540
4,414
48
5
17,428
Source: Loblaw Companies Limited, 2012 Annual Report, 2013, op. cit.
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EXHIBIT 2: LOBLAW COMPANIES LIMITED INCOME STATEMENTS, 2011–2012
(IN $ MILLIONS EXCEPT PER SHARE AMOUNTS)
Years ended
Revenue
Cost of merchandise inventories sold
Selling, general and administrative expenses
Operating income
Net interest expense and other financing charges
Earnings before income taxes
Income taxes
Net earnings
Net earnings per common share
Basic
Diluted
2012
$
$
$
$
2011
31,604
24,185
6,224
1,195
$ 31,250
23,894
5,972
$ 1,384
351
844
210
634
327
1,057
288
769
2.25
2.23
$
$
2.73
2.71
Source: Loblaw Companies Limited, 2012 Annual Report, 2013, op. cit.
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EXHIBIT 3: SHOPPERS DRUG MART BALANCE SHEETS, 2011–2012 (IN $ MILLIONS)
Year ended
ASSETS
Current Assets
Cash & cash equivalents
Accounts receivable
Inventories
Prepaid expenses and deposits
Total current assets
Property and equipment
Investment property
Goodwill and intangible assets
Deferred tax assets
Other assets
Total Assets
LIABILITIES
Current Liabilities
Bank indebtedness
Accounts payable and accrued liabilities
Current portion of long-term debt
Other current liabilities
Total Current Liabilities
Long-term debt
Finance leases
Other long-term liabilities
Deferred tax liabilities
Total Liabilities
SHAREHOLDERS’ EQUITY
Share capital
Treasury shares
Contributed surplus
Accumulated other comprehensive loss
Retained earnings
TOTAL LIABILITIES & EQUITY
Dec 29, 2012 Dec 31, 2011
$
$
$
$
$
$
$
$
$
$
105
470
2,148
42
2,765
$
$
1,718
16
2,913
39
23
7,474
$
171
1,207
450
507
2,335
$
247
123
399
47
3,150
$
$
$
$
1,431 $
11
(35)
2,916
7,474 $
119
493
2,042
41
2,696
1,768
16
2,781
21
18
7,300
172
1,109
250
245
1,776
696
118
404
39
3,032
1,486
(5)
10
(30)
2,806
7,300
Source: Shoppers Drug Mart, 2012 Annual Report, 2013, op. cit.
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EXHIBIT 4: SHOPPERS DRUG MART INCOME STATEMENTS AND OTHER FINANCIAL
INFORMATION, 2011–2012 (IN $ MILLIONS EXCEPT PER SHARE AMOUNTS)
Year ended
Sales
Cost of goods sold
Gross profit
Depreciation expense
Operating and administrative expenses
Operating income
Finance expenses
Earnings before income taxes
Income taxes
Current
Deferred
Net earnings
Net earnings per common share
Basic
Diluted
2012
$
$
$
$
10,782
6,609
4,173
263
3,029
881
58
823
2011
$ 10,459
6,416
4,042
249
2,882
$
911
64
$
847
236
21
215
608 $
209
24
233
614
2.92
2.92
2.84
2.84
236
204.5
390
212.5
Other Financial Information:
Capital expenditures
Shares outstanding at fiscal year end (millions)
Source: Shoppers Drug Mart, 2012 Annual Report, 2013, op. cit.
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