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Michelle Napoli is editor of Net Lease forum, from which this article is excerpted.

Camp Hill, PA—The country’s third-largest chain of drugstores–one of the most sought-after property types in the net lease market–will boost its standing and size with a deal for the US assets of a Canadian retailer valued at approximately $3.4 billion.

The agreement calls for Rite Aid Corp. to pay Longueuil, Quebec-based Jean Coutu Group Inc. $1.45 billion in cash and assume $850 million of debt as part of the consideration for the 1,858 US stores that currently bear the Eckerd and Brooks banners. When the transaction is closed, Rite Aid will have about 5,000 stores and will constitute the largest drugstore chain on the East Coast.

Jean Coutu is not forsaking the US drugstore business, however. The remainder of the deal’s consideration will take the form of a 32% equity interest in Rite Aid. In addition, Michel Coutu, president of the Jean Coutu Group’s US operations, will become co-chairman of Rite Aid as part of the agreement. Mary Sammons will continue as Rite Aid’s president and CEO and has been named chairman of Rite Aid’s Board of Directors.

The acquired stores will be re-branded Rite Aid and the company will continue to be headquartered in Camp Hill, PA. The stores are located in 18 states, including four new markets for Rite Aid: Massachusetts, North Carolina, Rhode Island and South Carolina. The deal also involves the acquisition of six distribution centers and the Warwick, RI corporate headquarters of Jean Coutu Group USA.

In an announcement, Sammons says the deal accelerates the company’s growth strategy, particularly in areas involving new store development. She notes the Brooks and Eckerd stores are in good locations and gives Rite Aid scale comparable to its major competitors. “We believe this enables us to compete more effectively in a highly competitive business,” she adds. Rite Aid says it remains on target with its new store development program, with plans to open 800 to 1,000 new stores during the next five years.

While number three among the national chains, Rite Aid has not shared the strong favor enjoyed in recent years among net lease real estate investors by its larger two competitors–Walgreen Co. and CVS Corp. One net lease property broker predicts investors will be less likely to want Brooks or Eckerd locations now that they will be converted to and backed by Rite Aid. But another broker thinks the acquisition of the Brooks and Eckerd stores will be a plus for Rite Aid. “I think it’s a net positive for Rite Aid, no question about it,” says Bernard Haddigan, the Atlanta-based managing director of Marcus & Millichap Real Estate Investment Brokerage Co.’s national retail group. He adds the deal will help Rite Aid continue to tidy up its balance sheet and ultimately help the company finance more development. He also says he expects Rite Aid to continue to use sale-leasebacks, which will now be utilized as a means of paying for the Jean Coutu deal.

The reaction among the credit ratings agencies was decidedly negative for Rite Aid and mixed for Jean Coutu. All three leading agencies placed Rite Aid on review for a possible downgrade. Rite Aid currently has a CCC+ senior unsecured notes rating from Fitch Ratings, a B2 corporate credit rating from Moody’s Investors Service and a B+ corporate credit rating from Standard & Poor’s Ratings Services “The increased financial risk and challenges of integrating the acquired stores could result in a lower credit rating,” says S&P New York City-based credit analyst Gerald A. Hirschberg in a ratings announcement.

“While Coutu’s US business to be acquired by Rite Aid generated reported fiscal 2006 Ebitda of $368 million, excluding non-recurring charges, the addition of funded debt of at least $2.3 billion plus Coutu’s US leases will exacerbate Rite Aid’s already high leverage,” adds Moody’s. “This acquisition of 1,858 stores is also large relative to Rite Aid’s existing base of 3,319 stores, potentially posing integration challenges. Strategically, however, the acquisition will give Rite Aid greater density and scale in its important Eastern markets with combined fiscal 2006 revenues of $26.8 billion.”

For Jean Coutu, meanwhile, Moody’s and S&P saw the news as a potential positive, with both ratings agencies putting the company on a review for a possible upgrade. Jean Coutu has B3 and B+ corporate credit ratings from Moody’s and S&P, respectively. “Although the credit impact to (Jean Coutu) is positive, given that the sale proceeds will allow for the company’s net debt position to be close to zero following the repayment of its revolving credit facilities and senior unsecured notes, (the company) will become a much smaller regional Canadian operator…”

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