About Alexandra Biesada

The rivalry between the nation’s two leading drugstore chains –- Walgreen and CVS –- is heating up as they battle for one of the last big prizes in the chain drugstore industry: Longs Drug Stores.

With some 520 stores in Hawaii, California, Nevada, and Arizona, Longs Drug Stores is indeed desirable.

Last month CVS bid $71.50 per share (about $2.9 billion) to acquire the chain, citing its valuable store locations in fast-growing markets. Indeed, in its press release CVS noted that it had “conservatively valued the store locations alone at more than $1 billion,” adding that Longs’ stores were situated in markets where “commercial real estate values are among the highest in the country.”

So it should come as no surprise that after boasting about Longs’ real estate riches, CVS met with rejection from Longs’ shareholders on the basis that its offer undervalues the chain’s property assets. Advisory Research Inc., which holds about 9% of Longs’ stock, has said it will not tender its shares to CVS at the $71.50-per-share price. The New York hedge fund Pershing Square Capital Management, led by the activist shareholder William Ackman, also rejected the CVS offer as too low and called for a competitive sale.

Enter Walgreen, which on Friday made an unsolicited bid of $75 per share for Longs. Yesterday, Longs rejected Walgreen’s sweeter offer and said its board continues to recommend the CVS deal to shareholders. (CVS has extended the expiration date for the tender offer to October 15 from September 15.) CEO Tom Ryan has said CVS is “not moving” on its price.

It’s hard to imagine that Walgreen will walk away or that Longs’ investors will settle for less than $75 per share. (Earlier this week Longs’ shares topped $76 per share, an all-time high.) Walgreen has said it’s prepared to take its offer directly to Longs’ shareholders, and it has offered to pay the $115 million termination fee if the Longs/CVS deal falls through.

While Walgreen has historically steered clear of big acquisitions, preferring to build its own stores, Longs is too luscious to let slip away. Longs’ presence in key West Coast markets, plus the fact that if CVS prevails its store count will surpass Walgreen’s, make winning Longs’ hand imperative.

Walgreen has deep pockets, possibly deeper than CVS’s following its $26.5 billion purchase of pharmacy benefits manager Caremark just last year. Longs’ savvy shareholders are itching for a bidding war and have raised the possibility of other potential bidders, including real estate players and retail giant Wal-Mart Stores. My guess is that ultimately CVS will have to raise its $71.50 offer to have a chance of landing Longs.

Discount department store operator Mervyn’s, which filed for Chapter 11 bankruptcy protection back in July, is suing its current owners and Target, alleging that the 2004 leveraged buyout of the firm from Target was a fraudulent transfer that ultimately doomed it to bankruptcy.

At first glance, Mervyn’s looked to be yet another casualty of the economic downturn and the difficult operating environment for retailers in general. With about 125 of its 175 stores located in California, where plummeting housing values and rising gas prices have put the squeeze on the chain’s core customers, Mervyn’s appeared to be a particularly vulnerable company in a teetering industry. But Mervyn’s, which has weathered previous downturns, says it has a bigger problem.

In papers filed by the company on Tuesday with the US Bankruptcy Court, Mervyn’s alleges that it was the victim of a plot by its new owners to strip it of its valuable real estate assets and then lease the properties back to the company at “substantially increased rates.” Mervyn’s claims that its annual occupancy expense (aka rent) has increased by about $80 million to $172 million after the sale. The filing goes on to claim that by “separating the firm’s real estate assets from its retail operations, the private equity owners — Cerberus Capital Management, Sun Capital Management, and Lubert-Adler and Klaff Partners — made sure that any residual value or upside in the real estate assets were reserved for themselves and not for Mervyn’s.” The three investors used loans against Mervyn’s real estate assets to finance the $800 million LBO from Target.

The company was founded in 1949 by Mervin Morris and acquired by Dayton Hudson (now Target) in 1978. Other defendants named in the suit include Goldman Sachs (Target’s investment banker), and the banks and real estate lenders involved in the deal.

Mervyn’s, which is still open for business but is shuttering 26 stores as it reorganizes, alleges that its owners have extracted $400 million from the company since acquiring it from Target, leaving it strapped for cash to pay vendors. The suit seeks the return of $58 million in transaction fees and other damages as well as a court order allowing Mervyn’s to reclaim its real estate.

The lawsuit may be among the first to address what has become a popular strategy among private equity firms in recent years. Acquirers take advantage of high real estate values to finance the purchase of retailers, such as Mervyn’s and ShopKo Stores (another Sun Capital deal), and then separate the underlying real estate from the retail business. Retailers who favor sale lease-back transactions say they provide money to open new locations and remodel existing ones. Indeed, ailing merchants like Sears and Kmart have attracted investors (enter Eddie Lampert) not for their retail operations but rather for the valuable land underneath their stores.

The current steep decline in commercial real estate values may put the brakes on the practice. But for Mervyn’s, and other ailing retailers who entered into real estate-backed LBOs, it may be too late.

When the mercury dips below 95 degrees here in Central Texas it can only mean one thing: The back-to-school shopping season is upon us. Actually, yesterday was the first day of school for my daughters, while parents in the Northeast and other parts of the country still have a week or so before the first bell rings in a new school year.

With an estimated $51 billion in back-to-school spending on the line, retailers are competing fiercely to capture as many of those dollars as possible. Given the hobbled state of the US economy, it comes as no surprise to learn that back-to-school (grades K-12) spending is expected to rise only modestly this year vs. last, while back-to-college spending will actually drop an estimated seven percent, from an average of $641.56 per student in 2007 to about $599 this year, according to the National Retail Federation’s 2008 Back to School Consumer Intentions and Actions Survey.

With the turmoil in the student loan industry and sky-high tuition bills it’s no wonder that parents of college bound students are spooked. But they’re not alone. Parents of younger kids are searching for bargains like never before to outfit their children for school. Indeed, about a fifth of thrifty parents nationwide report having set aside a portion of their tax rebate checks to cover back-to-school purchases, says the NRF.

One bright spot in the back-to-school outlook is electronics spending. While purchases of apparel, shoes, and school supplies are expected to rise only modestly this year over last, spending on computers and (gasp!) cell phones for kids are expected to enjoy double digit increases. That’s good news for chains like Best Buy, which was already outperforming its competitors and retailers in other categories prior to the back-to-school rush. (Wal-Mart is also aggressively courting the electronics shoppers with deals on lap tops, etc.)

Speaking of the back-to-school rush, while the NRF study reports that about 45% of parents will begin shopping at least three weeks before school starts, the majority of shoppers will opt for a more last-minute approach. My family could be found a mere 48 hours before school began combing the aisles of Target, OfficeMax, and The Gap frantically checking items off our school supply lists. Both by procrastinating and visiting discount and office supply chains we were fairly typical back-to-school shoppers: 73 percent of consumers will visit discount stores, such as Target and Wal-Mart, for back-to-school supplies while more than 40 percent will shop at office supply stores.

For those who’ve yet to begin their back-to-school shopping, you’ve got company. Nearly 4% of us begin shopping the week school starts, while about 2% wait until after the first bell has rung.

There’s an old saying that goes something like this: Be careful what you wish for, lest it come true. Take heed John Mackey!

Let me explain. In a previous post (read here) I mentioned that the Whole Foods Market founder and CEO was quoted as saying that if he could go back in time “we wouldn’t have done the Wild Oats acquisition.” Now a US appeals court ruling reversing the decision that allowed the $565 million purchase to proceed, has put the deal on hold, at least temporarily. The court has remanded the case for reconsideration to US District Judge Paul Friedman, saying that he erred when he dismissed the Federal Trade Commission’s claim that the deal violated antitrust law. The FTC opposes the combination saying it could stifle competition and lead to higher grocery prices.

From the point of view of WFM, the deal is a fait accompli as the company has already closed some Wild Oats stores, sold others, and is well down the road toward integration of the two chains. However the ruling, which states that “only in a rare case would we agree a transaction is truly irreversible,” leaves the door open for redress if the acquisition of Wild Oats is found to be unlawful. Of course, that has yet to be determined. (Read the appeal court’s opinion here.)

But even the prospect of reversal begs the question: How do you undo a (largely) done deal?

Potential consequences include a freeze on any further integration of the two chains, including ordering WFM not to close or rename any more Wild Oats stores. And if the FTC ultimately prevails it could order WFM to divest the Wild Oats stores it acquired to be run independently.

In a statement, WFM said that it was disappointed with the court’s ruling and was considering its legal options. Until then, the continuing integration of the Wild Oats business is in limbo while Whole Foods awaits the District Court’s response.

I wonder what Mackey is wishing now?

In my last post I noted that Costco Wholesale, the nation’s largest wholesale club (ahead of SAM’S CLUB), posted a healthy 5% same-store-sales gain in June, while less price-sensitive retailers showed weaker results. Now an update on Costco’s financial health reveals that the rise in sales came at the expense of profits as the company held the line on prices — even as its own costs rose — to please its members.

On Wednesday Costco warned that its fourth-quarter earnings (for the period ending Aug. 31) would come in well below analysts’ expectations. The warehouse club operator cited inflation, particularly high energy costs, as a root cause. Chief Financial Officer Richard Galanti noted in the announcement that Costco has been “holding selling price points to help drive sales and maintain the confidence of our members.”

Wall Street, not known for its loyalty, was quick to respond: Costco’s share price, up nearly 18% over the past year, fell almost 12% despite the company’s declaration of a quarterly cash dividend of $0.16 per share and an additional stock repurchase program of up to $1 billion. (That’s in addition to the $5.8 billion repurchase plan previously announced.)

Clearly, Costco is struggling to balance the interests of its shareholders with those of its members. So far, it appears to be favoring members. Loyal Costco shoppers, who are more affluent than members of rivals SAM’S Club and BJ’s Wholesale Club, have rewarded the retailer by renewing their memberships and buying more of its merchandise. Galanti noted that Costco’s sales continue to be strong relative to other retailers.

Wall Street, which in the past has knocked the company for lavishly rewarding employees with generous salaries and benefits at the expense of its bottom line, apparently feels that investors are getting short changed again.

Still as food, fuel, and other commodity prices continue to rise, Costco will eventually reach the point where it’s forced to blink and raise prices. In the meantime, Costco appears willing to see margins suffer in order to defend, and perhaps win, market share.