BIG DEAL ROCKS CANADIAN HEALTHCARE

TODAY'S TAKEAWAYS

• HAVE A STRATEGY? Opportunistic buying only works to accumulate size; it never succeeds in building strategic business units. ?As a result, it always fails in the long run.? Even if your strategy is initially wrong, you're better off with it than without it, because the planning process that created the strategy will enable you to adapt and change course.? McKesson never had a strategy, it only bought whatever was available.
• ADAPT TO CHANGING MARKET CONDITIONS? When McKesson started buying pharmacies in 2008, the only criterion for success was size.? But in 2014 the landscape changed completely when Loblaws acquired Shoppers Drug Mart, providing Shoppers with access to grocery products and dramatically changing Shoppers' marketing model.? McKesson failed to strategically respond with a grocery chain alliance.
• HUBRIS – 'excessive self-confidence' that inescapably leads to one's downfall – is self-destructive.? McKesson bought a dominant position in Canadian drug wholesaling in 1991. But their dominance in wholesaling blinded McKesson to the need to adapt to changing market conditions in retailing. McKesson failed to respond to Loblaws acquisition of Shoppers in 2014, leading to the inevitable implosion of their acquisition dream in 2024.

McKesson Corporation is an American giant.? Ninth largest on the Fortune 500 list.? Revenue in 2023 was US$276 Billion.

McKesson Canada is smart, aggressive and growth-driven. ?It supplies 1/3 of all the medications used in Canada every day.? They are the elephant in the Canadian pharma retailing room.

So when McKesson bails on the Canadian retail drug market, the Canadian healthcare sector and all its governmental regulators need to sit up and pay attention.

McKesson has been a dominant player in Canadian pharma wholesaling since 1991.? But wholesaling isn't lucrative.? You're the meat in the sandwich between the producer and the retailer; your profit margins are thin.? It's best to be vertically integrated with the retailers so that you can capture their additional profit margins.

So McKesson developed a strategy for Canadian growth:? buy hundreds of pharmacies, integrate them with its supply business, print money.? And they threw unprecedented amounts of money into a massive consolidation play in the Canadian retail drug market:

Historically, pharmacies were very profitable businesses.? But, over the last decade, while McKesson was spending money on acquisitions like a drunken sailor, the dynamics of the Canadian retail pharma industry deteriorated steadily.? This industry is now beset by a litany of structural problems:

INCREASED COMPETITION?- The emergence of strong pharmacy chains has increased competition, requiring more aggressive pricing (lower revenue and profit margins) and expanded product selection (higher inventory and financing costs).

REGULATORY CONSTRAINTS?- Government regulates both drug prices and dispensing fees in Canada. Shortly after McKesson acquired Rexall, new Federal rules slashed prices on generic drugs; and most provincial governments have not increased prescription dispensing fees in a decade.

HIGHER OPERATING COSTS?- Profit margins are squeezed by cost inflation, exacerbated by higher minimum-wage laws in Alberta and Ontario.

McKesson Canada consolidated its pharmacy acquisitions under Rexall Pharmacy Group ULC. The Rexall Drugs banner was more than 100 years old and had substantial brand value in the Canadian retail pharma market.

But, Rexall has 2 major problems.

FIRST, Rexall is stagnant.? Its store locations often are not prime real estate.? Its product selection is thin in key categories.? Its branding and loyalty programs are weak.? Rexall needs to grow.

Rexall's best shot at growth is in retail where 'front-of store' items like cosmetics generate premium margins. But Rexall has a major disadvantage.? It isn’t integrated with a retail parent. ?So, unlike its key competitors, Rexall isn't embedded in or owned by big-box retailers and it doesn't have access to cross-merchandising opportunities with skilled grocery retailers.

Rexall tried to evolve. ?In 2019 it partnered with frozen-food specialist M&M Foods to compete with Shoppers Drug Mart food offerings. ?And in 2020 it launched its own loyalty program, called "Be Well" – but to do that it had to dump its prior loyalty program, Air Miles, so it lost access to all its historical customer data.

So tell me.......When was the last time you bought an M&M frozen dinner at Rexall or used their "Be Well" loyalty program.? That's right: never!? Suffice to say, McKesson is great in pharmaceutical distribution but they don't do 'retail' well.

SECOND, McKesson Canada's C-suite is a revolving door. They've had 3 CEO's in the last 6 years. All of them have been retail merchandisers, intended to fix the problems at Rexall, but none of them have succeeded. This never-ending leadership upheaval is very damaging to Rexall's ability to effectively execute on its competitive strategy.

AS A RESULT of these challenges, in 2018 Rexall shut nearly 10% of its pharmacies and McKesson Corporation (the U.S. parent) announced it would take an after-tax asset-impairment charge tied to Rexall of more than US$600 Million.

Under a Global Settlement negotiated with 42 U.S. states in 2020, McKesson Corporation (the U.S. parent) agreed to pay US$7.4 Billion to settle claims against it arising from its role in providing drugs that fuelled the opioid crisis in the U.S.

It's no surprise, then, that McKesson Corp. is retrenching on its global footprint. ?It needs cash for legal bills.

Thus, in 2021, the company sold its British business and its European businesses in France, Italy, Ireland, Portugal, Belgium and Slovenia.

Fifteen years and a pandemic later, McKesson's consolidation play has bombed.

Now it's time for McKesson to dump their Canadian retail operations, which aren't generating much operating profit but can produce useful amounts of cash in a sale.

Who may step up to the plate as a buyer?

The pool of potential buyers includes rival chains who want to expand their footprints:

• CANDIDATE # 1 - Jean Coutu , which is based in Quebec and for whom Rexall's predominantly non-Quebec exposure would provide national expansion, would be in it for sure.? Jean Coutu is owned by Metro Inc. , the national grocery chain, which has sufficiently deep pockets to make this happen.
• CANDIDATE # 2 - Shoppers Drug Mart (owned by Loblaw Companies Limited ) could be in the game, but it would likely face anti-competition challenges because this acquisition would make them too dominant in the industry.

In addition, there are private equity firms, many of whom are flush with cash and some of whom specialize in retail turnarounds:

• CANDIDATE # 3 - An outside candidate is Neighbourly Pharmacy , owned by private equity firm Persistence Capital Partners .? Persistence Capital has aggressively grown Neighbourly Pharmacy over recent years and this acquisition would give it real national reach. However, this would be the minnow swallowing the whale which is exceedingly difficult from a post-acquisition integration perspective. Moreover, the size of this deal would likely be beyond Persistence Capital's financial capability.

In the end, the matter may simply come down to price. ?What is McKesson willing to accept to get Rexall off its hands and generate some cash?

Given the huge write-down that McKesson took on Rexall in 2018 combined with Rexall's lacklustre performance, to get a deal done McKesson may have to unload Rexall at a loss.

Credits:? McKesson Canada Corporation (website); The Globe and Mail (2016-03-02, 2017-04-12, 2020-11-03, 2024-01-11; 2024-01-15); Wikipedia

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